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Tuesday, October 26, 2010

National Photo Co. Those were the days January 31, 1925 "Police raid on gamblers' den, E Street between 12 and 13th, Washington, D.C."

Ilargi: To order Stoneleigh's video presentation of "A Century of Challenges", the lecture that's receiving rave reviews across Europe and North America, CLICK HERE or click the button on the right hand side just below the banner.

The abnormal state of the credit markets came into focus as the US Treasury sold bonds with negative interest rates for the first time and Goldman Sachs prepared to issue its first 50-year debt deal. Both developments on Monday highlighted the difficult choices facing investors at a time when interest rates are at historical lows and the Federal Reserve is moving towards more asset purchases aimed at boosting the economy and staving off deflation. Investors who believe the Fed will succeed in its efforts – which would lead to higher inflation – accepted a yield of minus 0.55 per cent on $10bn of Treasury Inflation Protected Securities – or Tips – which compensate holders if the consumer price index rises.

Ilargi: Now of course we must realize that in a market place where 70% of stocks are held for all of 11 seconds before being sold off again, things can happen that appear irrational, and we should ponder who purchases negative interest rate bonds and why. Still, there are those who feel that Bernanke's FOMC QE2 announcement next Wednesday will push up the consumer price index to levels which make these TIPS a profitable investment.

If they'd read through John Hussman's "Bernanke Leaps into a Liquidity Trap", they might come away with a whole lot of questions about that potential profit, though. Provided they intend to hold on to them for more than 11 seconds.

Ironically, Hussman explains why inflation does not mean rising prices, even as he uses it in exactly that meaning. He states that the monetary base can be enlarged without rising prices as a result, because the velocity of money will of necessity sink in the process, provided interest rates are low enough.

Just as ironic is it that it's Keynes himself who wrote about this fact, which should be a reminder for all Keynesian economists to go back and read his work once more. They might have missed a line or two. Sure, there may be a link to the realization that QE is but a swap of short-term for long-term debt, but the ground principle remains the same.

In her famous lecture A Century Of Challenges, The Automatic Earth's Stoneleigh uses the following image to explain what the liquidity trap is. The Fed can keep on pumping money, but it can't make it move. If you're fearful or uncertain, you will hold on to what you got, not spend it.

Stoneleigh compares it to "running your car with the oil light on". That is to say, the liquidity trap results in an economy without sufficient lubricant (credit, money) to run in a healthy fashion.

According to John Hussman, and we fully agree, this is an inevitable consequence of attempts, like QE2, to grow the money and credit supply in the face of -ultra- low interest rates. For which the Fed, -wait, more irony?!- is up to now single-handedly responsible. Obviously, this is not new: QE1 had the same effect, nothing reached the real economy it was ostensibly intended for, even though no such thing was ever admitted by either Bernanke, Geithner or Obama. QE1, like QE2, will only help, and both were indeed designed with this sole purpose in mind, to keep the broke broker broken banks standing for a while longer, at the cost of the taxpayer.

Here's a generous amount of quotes from Hussman on the topic, in order to get the idea through:

"There is the possibility... that after the rate of interest has fallen to a certain level, liquidity preference is virtually absolute in the sense that almost everyone prefers cash to holding a debt at so low a rate of interest. In this event, the monetary authority would have lost effective control.

”John Maynard Keynes, The General Theory

Keynes himself did not focus much of his analysis on the idea, so much of what passes for debate is based on the ideas of economists other than Keynes, particularly Keynes' contemporary John Hicks.

In the Hicksian interpretation of the liquidity trap, monetary policy transmits its effect on the real economy by way of interest rates. In that view, the loss of monetary control occurs because at some point, a further reduction of interest rates fails to stimulate additional demand for capital investment.

Alternatively, monetary policy might transmit its effect on the real economy by directly altering the quantity of funds available to lend. In that view, a liquidity trap would be characterized by the failure of real investment and output to expand in response to increases in the monetary base (currency and reserves).

In either case, the hallmark of a liquidity trap is that holdings of money become "infinitely elastic." As the monetary base is increased, banks, corporations and individuals simply choose to hold onto those additional money balances, with no effect on the real economy.[..]

A related way to think about a liquidity trap is in terms of monetary velocity: nominal GDP divided by the monetary base. Velocity is just the dollar value of GDP that the economy produces per dollar of monetary base. You can also think of velocity as the number of times that one dollar "turns over" each year to purchase goods and services in the economy. [..]

Falling velocity implies that a given stock of money is being hoarded, so that nominal GDP is growing slower than the stock of money. If velocity falls, holding the quantity of money constant, you'll observe either a decline in real GDP or deflation.

The belief that an increase in the money supply will result in an increase in GDP relies on the assumption that velocity will not decline in proportion to the increase in money. Unfortunately for the proponents of "quantitative easing," this assumption fails spectacularly in the data - both in the U.S. and internationally - particularly at zero interest rates.[..]

... a Keynesian liquidity trap occurs at the point when interest rates become so low that cash balances are passively held regardless of their size. The relationship between interest rates and velocity therefore goes flat at low interest rates, since increases in the money stock simply produce a proportional decline in velocity,

One might argue that while short-term interest rates are essentially zero, long-term interest rates are not, which might leave some room for a "Hicksian" effect from QE - that is, a boost to investment and economic activity in response to a further decline in long-term interest rates. The problem here is that longer-term interest rates, in an expectations sense, are already essentially at zero. [..]

So QE at this point represents little but an effort to drive risk premiums to levels that are inadequate to compensate investors for risk. This is unlikely to go well. Moreover, as noted below, the precise level of long-term interest rates is not the main constraint on borrowing here. The key issues are the rational desire to reduce debt loads, and the inadequacy of profitable investment opportunities in an economy flooded with excess capacity.

One of the most fascinating aspects of the current debate about monetary policy is the belief that changes in the money stock are tightly related either to GDP growth or inflation at all. Look at the historical data, and you will find no evidence of it. [..]

You can see why monetary base manipulations have so little effect on GDP by examining U.S. data since 1947. Expand the quantity of base money, and it turns out that velocity falls in nearly direct proportion.[..]

Simply put, monetary policy is far less effective in affecting real (or even nominal) economic activity than investors seem to believe. The main effect of a change in the monetary base is to change monetary velocity and short term interest rates. Once short term interest rates drop to zero, further expansions in base money simply induce a proportional collapse in velocity.[..]

... if one examines economic history, one quickly discovers that just as lower nominal interest rates are associated with lower monetary velocity, negative real interest rates are associated with lower velocity of commodities (hoarding). [..] The tendency toward commodity hoarding is particularly strong when economic conditions are very weak and desirable options for real investment are not available.

Quantitative easing promises to have little effect except to provoke commodity hoarding, a decline in bond yields to levels that reflect nothing but risk premiums for maturity risk, and an expansion in stock valuations to levels that have rarely been sustained for long [..]

In 1978, MIT economist Nathaniel Mass developed a framework for the liquidity trap based on microeconomic theory[..]: The weak impact of monetary stimulus on real activity arises because additional money has little force in stimulating additional capital investment during a period of general overcapacity. Instead, money is withheld in idle balances when profitable investment opportunities are scarce."

"Even aggressive monetary intervention can do little to correct excess capital.. Once excess capacity develops, the forces that previously led to aggressive expansion are almost played out. Efforts to prolong high investment can produce even more excess capital and lead to a more pronounced readjustment later."

Ilargi: One issue I left unaddressed before, of course, is that of commodity hoarding and money hoarding. Money hoarding is easy to see: bank reserves at the Fed have shot up with a vengeance. This is not because they’re afraid to lend, as we're told, but because they are aware of the losses that they haven't fessed up to, and that are just around the corner. Commodity hoarding is what takes place with gold, oil, food staples, anything investors feel can shield them from uncertainty and losses.

This may indeed lead to temporary price rises. But that's not inflation. It’s just rising prices. Inflation is the sum of money and credit supply multiplied by the velocity of money. And as we've just seen, that can't rise in times such as these. It can very much go down though, and that's what deflation means.

What can happen, and does, is that people choose to hold on to what they have, which lowers the velocity of money and temporarily raises -some- prices. This will end when they have to pay up their own debts.

And make no mistake: All that’s left is zombie money. The only "money" left is available solely because previously incurred debts haven't been paid off. That goes for all market participants: governments, companies, individuals.

Pension funds and other large investors wouldn’t have any money left to buy anything with, whether commodities, stocks or bonds, if the real estate related losses, including those on derivatives, were taken out of their deep dark moist and smelly hiding places. The only things that stand between banks, governments, large investors and oblivion are accounting gimmicks and perversely cheap credit provided at the behest of the taxpayer. Who, him/herself, need we extrapolate, only has plastic zombie "money" left as well.

But for now, sure, gold, stocks, bonds, everything that's not bolted down and then some, has this zombie money thrown at it.

Still, since this cheap credit is only possible at ultra-low interest rates, and these same interest rates in turn forbid any money-pumping from reaching the real economy, the Fed, and the American economy with it, is stuck in a dead-end street, with a steam roller heading its way.

The key point, or at least one of them, in Hussman's reasoning, is this:

"The weak impact of monetary stimulus on real activity arises because additional money has little force in stimulating additional capital investment during a period of general overcapacity."

There is no other possible conclusion then that all QE can possibly achieve today, effectively, is the transfer of public funds into private hands. And that that is all it's meant to do.

QE2 will be pushed through, whether it's to the tune of $2 trillion or $5 trillion or more, it has even already been priced in to a large extent, and conditions are being created as we speak that will seem to justify it to the public.

It will be pushed through exclusively for the benefit of the housing finance system, which consists of the big private banks as well as Fannie and Freddie, the FHA etc, all of whom are looking gigantic losses right in the eye.

However, if you listen to Bill Black, the notion creeps up that perhaps this one won’t be so easy to paper over, no matter how large QE2 turns out to be. Black gave us a taste in the Dylan Ratigan show:

Credit Suisse says that by 2006 49% of all mortgage originations were liars loans. When independent folks study fraud, it is in the 80-90% fraud range. That means there were millions of acts of fraud. Those loan frauds occurred because the banks created incentive structure for the loan brokers to bring them the absolute worst of the worst loans, and to lie on the application forms... These frauds came from the banks, and they propagated through the system through a series of echo epidemics...This fraud spread through the system and that's why we have a crisis in foreclosures. This stems from the underlying fraud by the lenders in mortgage loans to the tune of well over a million cases a year by 2005."

Ilargi: Also, Black and L. Randall Wray posted a second installment of their views at Huffington Post, in which they make a claim that's not overly recognized so far: the mortgage industry meant for homeowners to default. Which, when it comes to deception, is right up there with the Fed meaning for the QE2 trillions to go to the banks instead of the real economy.

There was fraud at every step in the home finance food chain: the appraisers were paid to overvalue real estate; mortgage brokers were paid to induce borrowers to accept loan terms they could not possibly afford; loan applications overstated the borrowers' incomes; speculators lied when they claimed that six different homes were their principal dwelling; mortgage securitizers made false reps and warranties about the quality of the packaged loans; credit ratings agencies were overpaid to overrate the securities sold on to investors; and investment banks stuffed collateralized debt obligations with toxic securities that were handpicked by hedge fund managers to ensure they would self destruct.

That homeowners would default on the nonprime mortgages was a foregone conclusion throughout the industry -- indeed, it was the desired outcome. [..]

When the overburdened homeowner began missing payments, late fees and higher interest rates kicked-in, boosting the stated income of mortgage servicers and the value of the securities. Not coincidentally, the biggest banks own the servicers and could maximize claims against the mortgages by running up the late fees. It was quite convenient to "misplace" mortgage payments, so even homeowners who were never delinquent could get hit with fees and higher rates. And when payments were received, the servicers would (illegally) apply them first to the late fees, meaning the homeowners were unknowingly still missing mortgage payments. The foreclosure process itself generates big fees for the SDI banks.

And, miracle of miracles, the banks would end up with the homes and get to restart the whole process again -- from resale of the home through the financing, securitizing, and fee-for-servicing juggernaut.[..]

We suggest an immediate moratorium on foreclosures and a requirement that all notes be produced by purported holders of mortgages within a reasonable length of time. If they cannot be found, the mortgages -- as well as the securities that pool them -- are no longer valid. That means that the homeowners are not indebted, and that the homes are owned free and clear. And that, dear bankers, is a big, big problem. It is also the law -- without evidence of debt, there is no debtor and no creditor.

An honest mortgage lender would not make "liar's loans" because absence of proper underwriting inherently produces loans that are expected to default. Yet, in 2006 just about half of all mortgages originated were liar's loans. Banks happily advertised specialization in "no doc" and NINJA loans. There can be no question about intent -- the intent was fraud, plain and simple. Fraud on the part of credit raters is equally easy to infer -- we have the internal emails that document intent to defraud securities purchasers by "pay to play" schemes. And the fraud committed by the investment banks that pooled the mortgages is also well documented. These entities committed tens of thousands and even millions of frauds each.

The "collateral damage" inflicted by the SDIs is now endangering tens of millions of American families -- most of whom played no role in the speculative euphoria. Almost half of American homeowners are already underwater or on the verge of going under. In short, it was Wall Street that turned our homes over to a financial casino -- and so far virtually all the losses have been suffered on Main Street.[..]

Closing the control frauds would actually benefit honest bankers by eliminating the "Gresham dynamics" created by fraudulent institutions -- a race to the bottom in underwriting. Since fraudulent banks use accounting fraud to manufacture high profits, they do not actually have to use a viable business model. By eliminating control fraud from the financial sector, it will be much easier for honest banks to succeed.

Further, the financial system has massive excess capacity -- as evidenced by the need to create bubble after bubble to find outlets for capacity. Almost all of the innovations in practice and instruments of the past two decades were spurred not by demand but rather by excess capacity. Downsizing the financial sector is critical to restoring it to a size that is commensurate with the needs of the economy.

The cost of not closing control frauds, by contrast, can be staggering. The business practices that maximize the fictional reported income (e.g., making "liar's loans to people who cannot repay their loans) maximize real losses and hyper-inflate financial bubbles. Control frauds destroy wealth at a prodigious rate. The one thing we certainly cannot afford is leaving the control frauds under the control of fraudulent CEOs.

Ilargi: Black is right in his proposals, every single one of them. He deserves all the kudos, respect and most of all support we can muster. Geithner, Bernanke and Eric Holder need to go, Bank of America and Citigroup need to be taken over, and all the paper needs to see daylight. Every single day that doesn't happen costs Americans billions of dollars, it really is as simple as that.

At the moment, for instance, Bank of America investigates its own loans, reluctantly comes up with some "errors", declares all else "sound", and resumes its foreclosures. That's just another joke: independent experts need to look at those loans. Why doesn't that happen? Why can BofA, Citigroup et al continue to be their own judge and jury? It's obviously not because of a lack of indications, or even proof, of questionable, illegal, fraudulent behavior. Just ask Bill Black.

At some point these questions will have to be answered, and the banks will have to reveal their true losses. Really, that time will come. Given the fact that right now the US election circus conveniently bogarts all media headlines, and that a likely Republican overall victory will paralyze the US political system afterwards, it looks more certain than ever that the ansers will not be provided by the government whose constitutional obligation it is to find them. The answers will need to come from the judicial system, from the non-mainstream media, and from the people themselves saying No Mas.

Tyler Durden: Bill Black, who will soon, together with Neil Barofsky, be a guaranteed shoe-in for the POTUS/VP position (both as independents, of course), was on the Ratigan show today, following on his op-ed from last week calling for the long-overdue nationalization of Bank of America, and discussing the rampant fraud at the heart of mortgage gate. And contrary to ongoing lowball estimates from the like of JPM and Goldman, Black provides numbers about the bank liability that are simply stunning:

"Credit Suisse says that by 2006 49% of all mortgage originations were liars loans. When independent folks study fraud, it is in the 80-90% fraud range. That means there were millions of acts of fraud. Those loan frauds occurred because the banks created incentive structure for the loan brokers to bring them the absolute worst of the worst loans, and to lie on the application forms... These frauds came from the banks, and they propagated through the system through a series of echo epidemics...This fraud spread through the system and that's why we have a crisis in foreclosures. This stems from the underlying fraud by the lenders in mortgage loans to the tune of well over a million cases a year by 2005."

Furthermore, Black points out the glaringly obvious, that the Fed should not be in charge of any investigation into mortgage fraud, due to its "massive" conflict of interest, to the tune of $1.5 trillion in MBS/agencies held on the Fed's books, which would be immediately null and voided if rampant MBS fraud is indeed uncovered. Which is precisely why the entitlement of the Fed as supreme regulator (as inspired by the financial generosity of the Wall Street lobby) as part of Frank-Dodd was the one single most destructive decision ever made, and equivalent in many ways with electing America's very own tyrannical despot, whose only interest is making the multi billionaires, into trillionaires, and leaving everyone else in the cold through the eliminating of the savings class and the destruction of the reserve currency.

And it goes much further... to the very top of the US ruling oligarchy in fact. Which is why, as we have claimed from day one, nothing less than a complete reset of the entire kleptocratic system can give any hope for a fresh start. The general public is starting to finally realize this, unfortunately with the dawning realization comes anger, and with anger comes aggression. And from there, broad civil "discontent" is merely a thin white line away. Which is why, we again reiterate our belief, now that America has completely missed its chance for a peaceful resolution, that the reset will have to go first and foremost through the Fed, whose end however will be precipitated by nothing less than an all out social upheaval. We agree with Black's conclusion: "fire Holder, fire Geithner, fire Bernanke, get people in who will enforce the rule of law."

Alas, it is too late. America has proven it has failed as a society in which checks and balances work when Wall Street dangles billion dollar bribes to corrupt and greedy individuals. And just like the market is stretched so far that it is always seconds away from a flash crash, so the entire US society is now mimicking our stock market, and the possibility for an all out social flash crash is no longer trivial.

Our call for closing down control frauds and stopping the foreclosure frauds typically meets with three objections. First, it is claimed that while there were some bad apple lenders, much of the fraud was committed by borrowers. Our proposal would let fraudulent borrowers remain in homes to which they are not entitled, punishing the banks that were duped. Second, the biggest banks are too important to foreclose. And third, it is not possible to resolve a "too big to fail" institution.

Who is Guilty?Let us deal with the "borrower fraud" argument first because it is the area containing the most erroneous assumptions.

There was fraud at every step in the home finance food chain: the appraisers were paid to overvalue real estate; mortgage brokers were paid to induce borrowers to accept loan terms they could not possibly afford; loan applications overstated the borrowers' incomes; speculators lied when they claimed that six different homes were their principal dwelling; mortgage securitizers made false reps and warranties about the quality of the packaged loans; credit ratings agencies were overpaid to overrate the securities sold on to investors; and investment banks stuffed collateralized debt obligations with toxic securities that were handpicked by hedge fund managers to ensure they would self destruct.

That homeowners would default on the nonprime mortgages was a foregone conclusion throughout the industry -- indeed, it was the desired outcome. This was something the lending side knew, but which few on the borrowing side could have realized. The homeowners were typically fraudulently induced by the lenders and the lenders' agents (the loan brokers) to enter into nonprime mortgages. The lenders knew the "loan to value" (LTV) ratios and income to debt ratios that they wanted the borrower to (appear to) meet in order to make it possible for the lender to sell the nonprime loan at a premium. LTV can be gimmicked by inflating the appraisal.

The debt to income ratios can be gimmicked by inflating income. "Liar's" loan lenders used that loan format because it allowed the lender to simultaneously loan to a vast number of borrowers that could not repay their home loans, at a premium yield, while making it look to the purchaser of the loan that it was relatively low risk. Liar's loans maximized the lender's reported income, which maximized the CEO's compensation.

The problem is that only the most sophisticated nonprime borrowers (the speculators who bought six homes) (1) knew the key ratios they had to appear to meet, (2) had the ability to induce an appraiser to inflate substantially the reported market value of the home, and (3) knew how to create false financial information that was internally consistent and credible. The solution was for the lender and the lender's agents to (1) instruct the borrower to report a certain income or even to fill out the application with false information, (2) suborn an appraiser to provide the necessary inflated market value, and (3) create fraudulent financial information that had at least minimal coherence.

When the overburdened homeowner began missing payments, late fees and higher interest rates kicked-in, boosting the stated income of mortgage servicers and the value of the securities. Not coincidentally, the biggest banks own the servicers and could maximize claims against the mortgages by running up the late fees. It was quite convenient to "misplace" mortgage payments, so even homeowners who were never delinquent could get hit with fees and higher rates. And when payments were received, the servicers would (illegally) apply them first to the late fees, meaning the homeowners were unknowingly still missing mortgage payments. The foreclosure process itself generates big fees for the SDI banks.

And, miracle of miracles, the banks would end up with the homes and get to restart the whole process again -- from resale of the home through the financing, securitizing, and fee-for-servicing juggernaut. Unfortunately, it did not go quite as smoothly as planned. The SDIs were supposed to act like neutron bombs -- killing the homeowners but leaving the homes standing, to be resold. The problem is that wiping out borrowers lowered the value of real estate, crushing not only the real estate market but also construction and through to all associated sectors from furniture and home restoration supplies to big ticket purchases that rely on home equity loans. It also led to questions about the value of the securitized toxic waste manufactured and held directly or indirectly by financial institutions.

Next, a few judges began to question the foreclosures, as they saw case after case in which the banks claimed to have lost the paperwork or submitted amateurishly forged documents. Or, several banks would go after the same homeowner, each claiming to hold the same mortgage (Bear sold the same mortgage over and over). Insiders began to offer depositions exposing fraud and perjury. It became apparent that in many and perhaps most cases, the trusts responsible for the securities (often these are "special purpose" subsidiaries of the banks) never received the "notes" signed by the borrowers -- as required by both IRS tax code and by 45 of the US states. Without the notes, billions of dollars of back taxes could be due, and the foreclosures violate state law. Finally, the Attorneys General of all fifty states called for a foreclosure moratorium.

What to do? We suggest an immediate moratorium on foreclosures and a requirement that all notes be produced by purported holders of mortgages within a reasonable length of time. If they cannot be found, the mortgages -- as well as the securities that pool them -- are no longer valid. That means that the homeowners are not indebted, and that the homes are owned free and clear. And that, dear bankers, is a big, big problem. It is also the law -- without evidence of debt, there is no debtor and no creditor.

Commentators are horrified that a foreclosure moratorium would let "deadbeat" borrowers remain in their homes while delinquent in their payments. The speculators that purchased "MacMansions" and stated on six separate loan applications that each house was their principal dwelling are frauds. The moratorium would (briefly) reward fraudulent borrowers while (briefly) punishing the fraudulent banks. This is true.

It is not possible to separate "worthy" borrowers who were duped by banks from all "unworthy" borrowers who knew the loan applications were false. Indeed, given the millions of borrowers that received liar's loans, even if the borrowers were all frauds we could not possibly prosecute all of them due to lack of resources. We currently prosecute roughly 1,000 mortgage fraud cases annually at the federal level. If we used all of our resources to investigate and prosecute fraudulent mortgage borrowers exclusively we would be able to prosecute less than one-tenth of one percent of those frauds.

The losses that the fraudulent nonprime lenders caused are vastly greater than the losses caused by fraudulent borrowers, so no rational prosecutor would use his scarce resources to prosecute individual nonprime borrowers. Moreover, prosecutions of individual borrowers for alleged fraud in the applications would be difficult to win against competent defense counsel because it will not be possible to infer the borrower's intent and knowledge and whether the loan agent instructed him to enter specified information on the application. We are not arguing that the speculator who committed fraud while buying six homes should be allowed to walk free. We are simply arguing that it makes no sense to use limited judicial resources to go after owner-occupier households where it will be almost impossible to prove intent to defraud.

On the other hand, we can infer a lender's fraudulent intent because it is financially sophisticated and has expertise in lending. An honest mortgage lender would not make "liar's loans" because absence of proper underwriting inherently produces loans that are expected to default. Yet, in 2006 just about half of all mortgages originated were liar's loans. Banks happily advertised specialization in "no doc" and NINJA loans. There can be no question about intent -- the intent was fraud, plain and simple. Fraud on the part of credit raters is equally easy to infer -- we have the internal emails that document intent to defraud securities purchasers by "pay to play" schemes. And the fraud committed by the investment banks that pooled the mortgages is also well documented. These entities committed tens of thousands and even millions of frauds each. For obvious efficiency reasons, that is where our judicial resources ought to be directed.

Macro Effects and CulpabilityThere is one other consideration that biases the case in favor of borrowers. Many homeowners were sold on the idea that "real estate values only go up" -- and quite a few planned to refinance on better terms, or even to flip the house at a price that would allow them to pay-off a mortgage they could not otherwise afford. We realize that it is not easy to shed tears for speculators foiled by the market, and that is not our point.

What is important to understand, however, is that the financial sector is largely culpable for the generation of speculative frenzy, the creation of the "financial weapons of mass destruction", and the transformation toward financial fragility that finally collapsed in 2007. In the aftermath we lost 10 million jobs and millions of homeowners lost their homes. The "collateral damage" inflicted by the SDIs is now endangering tens of millions of American families -- most of whom played no role in the speculative euphoria. Almost half of American homeowners are already underwater or on the verge of going under. In short, it was Wall Street that turned our homes over to a financial casino -- and so far virtually all the losses have been suffered on Main Street.

This culpability is at the aggregate scale and of course no individual bank can be held liable in court for the collapse of the financial system. Rather, each bank's guilt must be assessed according to its own fraud. However, a national moratorium on foreclosures must be evaluated at the macro level, and justified on the basis of the aggregate costs, benefits, and moral implications. And certainly at the aggregate level that must be considered by President Obama, the benefits to the majority of Americans clearly outweigh the costs imposed on the relatively few. And the morality is also on the side of homeowners and clearly against the banks.

Closing the control frauds would actually benefit honest bankers by eliminating the "Gresham dynamics" created by fraudulent institutions -- a race to the bottom in underwriting. Since fraudulent banks use accounting fraud to manufacture high profits, they do not actually have to use a viable business model. By eliminating control fraud from the financial sector, it will be much easier for honest banks to succeed.

Further, the financial system has massive excess capacity -- as evidenced by the need to create bubble after bubble to find outlets for capacity. Almost all of the innovations in practice and instruments of the past two decades were spurred not by demand but rather by excess capacity. Downsizing the financial sector is critical to restoring it to a size that is commensurate with the needs of the economy.

The cost of not closing control frauds, by contrast, can be staggering. The business practices that maximize the fictional reported income (e.g., making "liar's loans to people who cannot repay their loans) maximize real losses and hyper-inflate financial bubbles. Control frauds destroy wealth at a prodigious rate. The one thing we certainly cannot afford is leaving the control frauds under the control of fraudulent CEOs.

Can the Frauds be Foreclosed?The assertion that the SDIs cannot be resolved because of their size is unsupported. Very large institutions have already been resolved both in this country and abroad. The "too big to fail" (TBTF) doctrine has always been unproven, dangerous, and counter to the law. An institution that is not permitted to fail faces obvious adverse incentive problems. It also destroys healthy competition with institutions that are not considered TBTF. It encourages risk-taking and fraud. And it subverts the law, which requires that insolvent institutions must be resolved.

As we write this piece, the markets are taking it upon themselves to begin to close down the control frauds -- with homeowners fighting the foreclosures and investors demanding that the banks take back the toxic waste. Unfortunately, following the market solution will be a long-drawn-out and costly process -- both in terms of tying up the judicial system but also in terms of the uncertainty and despair that will persist. At the end of that process, the banks will have to be resolved. No matter how much the politicians dislike it, they will end up with the banks in their hands -- either now or later. Taking them now is the right thing to do.

Bad banks, and their bad business model of willful incompetence, are still alive, and dragging down the recovery.

Since the housing market peaked in 2006, the nation has suffered through nearly half a decade of financial and economic hell. It's past time for the politicians to do what they should have done in the first place. That is, protect the nation's priceless assets: the rule of law and free markets. Instead, the pols are protecting the worthless assets of zombie banks that do not know how to be banks.

Two years ago, many of the nation's largest banks should have failed — because their business model failed. That business model was willful incompetence. Back then, banks, including Countrywide Financial, now part of Bank of America, showcased this incompetence in helping homeowners borrow money they could never repay. Today, thanks to Washington's bailouts, the bad banks are still alive. So is their disastrous business model. The banks now showcase their incompetency in their inability to foreclose on defaulted homeowners in an orderly, timely and non-fraudulent fashion.

In the past two weeks, Bank of America, JPMorgan Chase and some competitors temporarily halted most foreclosures. The banks stopped foreclosing as employees came forward to say that they had defrauded courts — that is, falsely attested that they knew the facts of thousands of foreclosure cases when they did not. Often, the banks cannot locate the documents that confirm a lender's right to foreclose. Even as banks resume foreclosures, as Bank of America did this week, they have a motive to proceed slowly because they do not want to book the losses that come with property sales.

But the banks' dawdling imperils economic recovery, in ways prosaic and profound.

The prosaic: Borrowers stay stuck in homes they can't afford, meaning they can't get on with their lives. Prospective home buyers still can't afford property, and those who can remain wary because until lenders clear their backlog of foreclosures, house prices won't fall to realistic levels. At the same time, small businesses cannot create jobs because banks and investors stuck with old, bad loans don't want to make new ones.

The profound: Botched foreclosures erode the property rights on which the nation's prosperity rests. When a person buys a home, he must know that he enjoys the legal right to keep and sell that property. Property rights break down if, three years from now, a former owner can say that she did not get her day in court and therefore a sale should be invalidated.

Thankfully, regulators, including the Federal Reserve, have the power to act. Banks, after all, must operate safely and soundly. By definition, a financial institution cannot be safe and sound if its executives have no idea who owns what and who owes what. Nor can a bank operate safely and soundly if it cannot properly value its or its customers' assets, something it cannot do if it has not mastered the work of asserting legal rights to those assets.

Here's what Washington should do: Regulators should require banks to promptly fulfill their safety and soundness duties. Banks would do so, obviously, by foreclosing on defaulted homeowners in a timely, consistent and honest fashion, even if it means that the firms must shell out big money to hire enough qualified people. Alternatively, the banks could choose —in the same timely fashion— to reduce the amount of money that borrowers owe so that borrowers could afford to stay. One way or the other, it's time to get it over with.

Here's what Washington will do, though: nothing. Regulators know that if they force banks to foreclose quickly, legally and consistently, the firms would have to take significant, perhaps crippling, losses on the loans on their books. Fannie Mae and Freddie Mac, which hold and insure many loans, would have to take fresh losses too. Further, investors who purchased mortgage securities could sue, alleging, among other things, that underwriters misrepresented third parties' capacity to ensure that someone would oversee mortgage paperwork on a day-to-day basis.

In other words, big banks could fail. And that's the problem. Despite having signed into law the Dodd-Frank financial reform bill three months ago, the White House still has not created a predictable way in which large financial firms can go under, with investors taking warranted losses. Instead, the new law directs regulators to make up the job as they go along. Regulators are terrified of testing their discretion and of precipitating a 2008-style panic.

Smart bankers feel this fear. They know that regulators will not cause markets to question a large bank's viability, even if it means enabling the slow strangulation of economic recovery. This knowledge explains the banks' casual attitude toward their public trust. Banks remain permanent wards of the state, immune from full market and legal discipline.

As for the politicians, their policy is ignorance. President Obama doesn't want to have to ask for his own TARP. Congressional Republicans want no reminder of Bush-era bailouts. They maintain the fiction that the financial crisis is in the past.

Someday, reality will intrude, and it won't discriminate over whether a Democrat or a Republican is in the White House. In the meantime, Washington's policy of ignoring irretrievably broken banks could inflict another half-decade of "housing" crisis on the rest of us.

"There is the possibility... that after the rate of interest has fallen to a certain level, liquidity preference is virtually absolute in the sense that almost everyone prefers cash to holding a debt at so low a rate of interest. In this event, the monetary authority would have lost effective control.”John Maynard Keynes, The General Theory

One of the many controversies regarding Keynesian economic theory centers around the idea of a "liquidity trap." Apart from suggesting the potential risk, Keynes himself did not focus much of his analysis on the idea, so much of what passes for debate is based on the ideas of economists other than Keynes, particularly Keynes' contemporary John Hicks. In the Hicksian interpretation of the liquidity trap, monetary policy transmits its effect on the real economy by way of interest rates. In that view, the loss of monetary control occurs because at some point, a further reduction of interest rates fails to stimulate additional demand for capital investment.

Alternatively, monetary policy might transmit its effect on the real economy by directly altering the quantity of funds available to lend. In that view, a liquidity trap would be characterized by the failure of real investment and output to expand in response to increases in the monetary base (currency and reserves). In either case, the hallmark of a liquidity trap is that holdings of money become "infinitely elastic." As the monetary base is increased, banks, corporations and individuals simply choose to hold onto those additional money balances, with no effect on the real economy.

The typical Econ 101 chart of this is drawn in terms of "liquidity preference," that is, desired cash holdings, plotted against interest rates. When interest rates are high, people choose to hold less cash because cash doesn't earn interest. As interest rates decline toward zero (and especially if the Fed chooses to pay banks interest on cash reserves, which is presently the case), there is no effective difference between holding riskless debt securities (say, Treasury bills) and riskless cash balances, so additional cash balances are simply kept idle.

Velocity A related way to think about a liquidity trap is in terms of monetary velocity: nominal GDP divided by the monetary base. (The identity, which is true by definition, is M * V = P * Y. The monetary base times velocity is equal to the price level times real output).

Velocity is just the dollar value of GDP that the economy produces per dollar of monetary base.You can also think of velocity as the number of times that one dollar "turns over" each year to purchase goods and services in the economy. Rising velocity implies that money is "turning over" more rapidly, so that nominal GDP is increasing faster than the stock of money.

If velocity rises, holding the quantity of money constant, you'll observe either growth in real output or inflation. Falling velocity implies that a given stock of money is being hoarded, so that nominal GDP is growing slower than the stock of money. If velocity falls, holding the quantity of money constant, you'll observe either a decline in real GDP or deflation.

The belief that an increase in the money supply will result in an increase in GDP relies on the assumption that velocity will not decline in proportion to the increase in money. Unfortunately for the proponents of "quantitative easing," this assumption fails spectacularly in the data - both in the U.S. and internationally - particularly at zero interest rates.

How to spot a liquidity trap The chart below plots the velocity of the U.S. monetary base against interest rates since 1947. Since high money holdings correspond to low velocity, the graph is simply the mirror image of the theoretical chart above.

Few theoretical relationships in economics hold quite this well. Recall that a Keynesian liquidity trap occurs at the point when interest rates become so low that cash balances are passively held regardless of their size. The relationship between interest rates and velocity therefore goes flat at low interest rates, since increases in the money stock simply produce a proportional decline in velocity, without requiring any further decline in yields. Notice the cluster of observations where interest rates are zero? Those are the most recent data points.

One might argue that while short-term interest rates are essentially zero, long-term interest rates are not, which might leave some room for a "Hicksian" effect from QE - that is, a boost to investment and economic activity in response to a further decline in long-term interest rates. The problem here is that longer-term interest rates, in an expectations sense, are already essentially at zero. The remaining yield on longer-term bonds is a risk premium that is commensurate with U.S. interest rate volatility (Japanese risk premiums are lower, but they also have nearly zero interest rate variability).

So QE at this point represents little but an effort to drive risk premiums to levels that are inadequate to compensate investors for risk. This is unlikely to go well. Moreover, as noted below, the precise level of long-term interest rates is not the main constraint on borrowing here. The key issues are the rational desire to reduce debt loads, and the inadequacy of profitable investment opportunities in an economy flooded with excess capacity.

One of the most fascinating aspects of the current debate about monetary policy is the belief that changes in the money stock are tightly related either to GDP growth or inflation at all. Look at the historical data, and you will find no evidence of it. Over the years, I've repeatedly emphasized that inflation is primarily a reflection of fiscal policy - specifically, growth in the outstanding quantity of government liabilities, regardless of their form, in order to finance unproductive spending. Look at the experience of the 1970's (which followed large expansions in transfer payments), as well as every historical hyperinflation, and you'll find massive increases in government spending that were made without regard to productivity (Germany's hyperinflation, for instance, was provoked by continuous wage payments to striking workers).

Likewise, real economic growth has no observable correlation with growth in the monetary base (the correlation is actually slightly negative but insignificant). Rather, economic growth is the result of hundreds of millions of individual decision-makers, each acting in their best interests to shift their consumption plans, saving, and investment in response to desirable opportunities that they face. Their behavior cannot simply be induced by changes in the money supply or in interest rates, absent those desirable opportunities.

You can see why monetary base manipulations have so little effect on GDP by examining U.S. data since 1947. Expand the quantity of base money, and it turns out that velocity falls in nearly direct proportion. The cluster of points at the bottom right reflect the most recent data.

[Geek's Note: The slope of the relationship plotted above is approximately -1, while the Y intercept is just over 6%, which makes sense, and reflects the long-term growth of nominal GDP, virtually independent of variations in the monetary base. For example, 6% growth in nominal GDP is consistent with 0% M and 6% V, 5% M and 1% V, 10% M and -4% V, etc. There is somewhat more scatter in 3-year, 2-year and 1-year charts, but it is random scatter. If expansions in base money were correlated with predictably higher GDP growth, and contractions in base money were correlated with predictably lower GDP growth, the slope of the line would be flatter and the fit would still be reasonably good. We don't observe this.]

Just to drive the point home, the chart below presents the same historical relationship in Japanese data over the past two decades. One wonders why anyone expects quantitative easing in the U.S. to be any less futile than it was in Japan.

Simply put, monetary policy is far less effective in affecting real (or even nominal) economic activity than investors seem to believe. The main effect of a change in the monetary base is to change monetary velocity and short term interest rates. Once short term interest rates drop to zero, further expansions in base money simply induce a proportional collapse in velocity.

I should emphasize that the Federal Reserve does have an essential role in providing liquidity during periods of crisis, such as bank runs, when people are rapidly converting bank deposits into currency. Undoubtedly, we would have preferred the Fed to have provided that liquidity in recent years through open market operations using Treasury securities, rather than outright purchases of the debt securities of insolvent financial institutions, which the public is now on the hook to make whole. The Fed should not be in the insolvency bailout game. Outside of open market operations using Treasuries, Fed loans during a crisis should be exactly that, loans - and preferably following Bagehot's Rule ("lend freely but at a high rate of interest"). Moreover, those loans must be senior to any obligation to bank bondholders - the public's claim should precede private claims. In any event, when liquidity constraints are truly binding, the Fed has an essential function in the economy.

At present, however, the governors of the Fed are creating massive distortions in the financial markets with little hope of improving real economic growth or employment. There is no question that the Fed has the ability to affect the supply of base money, and can affect the level of long-term interest rates given a sufficient volume of intervention. The real issue is that neither of these factors are currently imposing a binding constraint on economic growth, so there is no benefit in relaxing them further. The Fed is pushing on a string.

Toy blocks Certain economic equations and regularities make it tempting to assume that there are simple cause-effect relationships that would allow a policy maker to directly manipulate prices and output. While the Fed can control the monetary base, the behavior of prices and output is based on a whole range of factors outside of the Fed's control. Except at the shortest maturities, interest rates are also a function of factors well beyond monetary policy.

Analysts and even policy makers often ignore equilibrium, preferring to think only in terms of demand, or only in terms of supply. For example, it is widely believed that lower real interest rates will result in higher economic growth. But in fact, the historical correlation between real interest rates and GDP growth has been positive - on balance, higher real interest rates are associated with higher economic growth over the following year. This is because higher rates reflect strong demand for loans and an abundance of desirable investment projects.

Of course, nobody would propose a policy of raising real interest rates to stimulate economic activity, because they would recognize that higher real interest rates were an effect of strong loan demand, and could not be used to cause it. Yet despite the fact that loan demand is weak at present, due to the lack of desirable investment projects and the desire to reduce debt loads (which has in turn contributed to keeping interest rates low), the Fed seems to believe that it can eliminate these problems simply by depressing interest rates further. Memo to Ben Bernanke: Loan demand is inelastic here, and for good reason. Whatever happened to thinking in terms of equilibrium?

Neither economic growth nor the demand for loans are a simple function of interest rates. If consumers wish to reduce their debt, and companies do not have a desirable menu of potential investments, there is little benefit in reducing interest rates by another percentage point, because the precise cost of borrowing is not the issue. The current thinking by the FOMC seems to treat individual economic actors as little unthinking toy blocks that can be moved into the desired position at will. Instead, our policy makers should be carefully examining the constraints and interests that are important to people and act in a way that responsibly addresses those constraints.

A good example of this "toy block" thinking is the notion of forcing individuals to spend more and save less by increasing people's expectations about inflation (which would drive real interest rates to negative levels). As I noted last week, if one examines economic history, one quickly discovers that just as lower nominal interest rates are associated with lower monetary velocity, negative real interest rates are associated with lower velocity of commodities (hoarding). Look at the price of gold since 1975.

When real interest rates have been negative (even simply measured as the 3-month Treasury bill yield minus trailing annual CPI inflation), gold prices have appreciated at a 20.7% annual rate. In contrast, when real interest rates have been positive, gold has appreciated at just 2.1% annually. The tendency toward commodity hoarding is particularly strong when economic conditions are very weak and desirable options for real investment are not available. When real interest rates have been negative and the Purchasing Managers Index has been below 50, the XAU gold index has appreciated at an 85.7% annual rate, compared with a rate of just 0.1% when neither has been true. Despite these tendencies, investors should be aware that the volatility of gold stocks can often be intolerable, so finer methods of analysis are also essential.

Quantitative easing promises to have little effect except to provoke commodity hoarding, a decline in bond yields to levels that reflect nothing but risk premiums for maturity risk, and an expansion in stock valuations to levels that have rarely been sustained for long (the current Shiller P/E of 22 for the S&P 500 has typically been followed by 5-10 year total returns below 5% annually). The Fed is not helping the economy - it is encouraging a bubble in risky assets, and an increasingly unstable one at that. The Fed has now placed itself in the position where small changes in its announced policy could have disastrous effects on a whole range of financial markets. This is not sound economic thinking but misguided tinkering with the stability of the economy.

Implications for Policy In 1978, MIT economist Nathaniel Mass developed a framework for the liquidity trap based on microeconomic theory - rational decisions made at the level of individual consumers and firms. The economic dynamics resulting from the model he suggested seem strikingly familiar in the context of the recent economic downturn. They offer a useful way to think about the current economic environment, and appropriate policy responses that might be taken.

"The theory revolves around a set of forces that for a period of time promote cumulative expansion of capital formation, but eventually lead to overexpansion of capital production capacity and then into a situation where excess capacity strongly counteracts expansionary monetary policies.

"The capital boom followed by depression runs much longer than the usual short-term business cycle, and is powerfully driven by capital investment interactions. The weak impact of monetary stimulus on real activity arises because additional money has little force in stimulating additional capital investment during a period of general overcapacity. Instead, money is withheld in idle balances when profitable investment opportunities are scarce."

In one illustration of the model, Mass introduces a monetary stimulus much like what Alan Greenspan engineered following the 2000-2002 recession (which was also preceded by an unusually large buildup of excess capacity, leading to an investment-led downturn). Though Greenspan's easy-money policy didn't prompt a great deal of business investment, it did help to fuel the expansion in another form of investment, specifically housing. Mass describes the resulting economic dynamics:

"Following the monetary intervention, relatively easy money provides a greater incentive to order capital... But now the overcapacity that characterizes the peak in the production of capital goods reaches an even higher level than without the stimulus. This overcapacity eventually makes further investment even less attractive and causes the decline in capital output to proceed from a higher peak and at a faster pace. Due to persistent excess capital which cannot be reduced as fast as labor can be cut back to alleviate excess production, unemployment actually remains higher on the average following the drop in production."

In what reads today as a further warning against Bernanke-style quantitative easing, Mass observed: "Even aggressive monetary intervention can do little to correct excess capital.. Once excess capacity develops, the forces that previously led to aggressive expansion are almost played out. Efforts to prolong high investment can produce even more excess capital and lead to a more pronounced readjustment later."

Mass concluded his 1978 paper with an observation from economist Robert Gordon: "Why was the recovery of the 1930's so slow and halting in the United States, and why did it stop so far short of full employment? We have seen that the trouble lay primarily in the lack of inducement to invest. Even with abnormally low interest rates, the economy was unable to generate a volume of investment high enough to raise aggregate demand to the full employment level."

I've generally been critical of Keynes' willingness to advocate government spending regardless of its quality, which focused too little on the long-term effects of diverting private resources to potentially unproductive uses. His remark that "In the long-run we are all dead" was a reflection of this indifference. Still, I do believe that fiscal responses can be useful in a protracted economic downturn, and can include projects such as public infrastructure, incentives for research and development, and investment incentives in sectors that are not burdened with overcapacity. Additional deficit spending is harmful when it fails to produce a stream of future output sufficient to service the debt, so the expected productivity of these projects is the essential consideration. Given present economic conditions, it appears clear that Keynes was right about the dangers of easy monetary policy when an economic downturn results from overcapacity.

Now for some really scary breaking news, from the latest payroll tax data.

Every 34th wage earner in America in 2008 went all of 2009 without earning a single dollar, new data from the Social Security Administration show. Total wages, median wages, and average wages all declined, but at the very top, salaries grew more than fivefold. Not a single news organization reported this data when it was released October 15, searches of Google and the Nexis databases show. Nor did any blog, so the citizen journalists and professional economists did no better than the newsroom pros in reporting this basic information about our economy.

The new data hold important lessons for economic growth and tax policy and take on added meaning when examined in light of tax return data back to 1950. The story the numbers tell is one of a strengthening economic base with income growing fastest at the bottom until, in 1981, we made an abrupt change in tax and economic policy. Since then the base has fared poorly while huge economic gains piled up at the very top, along with much lower tax burdens.

A weak foundation cannot properly support a massive superstructure, as the leaning Tower of Pisa shows. The latest wage data show the disastrous results some of us warned about, although like the famous tower, the economy only lists badly and has not collapsed. Measured in 2009 dollars, total wages fell to just above $5.9 trillion, down $215 billion from the previous year. Compared with 2007, when the economy peaked, total wages were down $313 billion or 5 percent in real terms.

The number of Americans with any wages in 2009 fell by more than 4.5 million compared with the previous year. Because the population grew by about 1 percent, the number of idle hands and minds grew by 6 million. These figures show, far more powerfully than the official unemployment measure known as U3, how both widespread and deep the loss of jobs was in 2009. While the official unemployment rate is just under 10 percent, deeper analysis of the data by economist John Williams at http://www.shadowstats.com shows a real under- and unemployment rate of more than 22 percent.

Only 150.9 million Americans reported any wage income in 2009. That put us below 2005, when 151.6 million Americans reported wages, and only slightly ahead of 2004, when 149.4 million Americans held at least one paying job. For those who did find work in 2009, the average wage slipped to $39,269, down $243 or 0.6 percent, compared with the previous year in 2009 dollars. The median wage declined by the same ratio, down $159 to $26,261, meaning half of all workers made $505 a week or less. Significantly, the 2009 median wage was $37 less than in 2000.

To give this some perspective, from 1992 to 2000 the number of people earning any wages grew by 21 million, but nine years later just 2.8 million more people had any work. These wage data, based on the Medicare flat tax on all compensation, tell us only about the number of people who earned wages and how much. They tell us nothing about whether these individuals were underemployed, had to work more than one job, earned fringe benefits, or were employed at a level commensurate with their abilities.

But they do give us a stunning picture of what’s happening at the very top of the compensation ladder in America. The number of Americans making $50 million or more, the top income category in the data, fell from 131 in 2008 to 74 last year. But that’s only part of the story. The average wage in this top category increased from $91.2 million in 2008 to an astonishing $518.8 million in 2009. That’s nearly $10 million in weekly pay!

You read that right. In the Great Recession year of 2009 (officially just the first half of the year), the average pay of the very highest-income Americans was more than five times their average wages and bonuses in 2008. And even though their numbers shrank by 43 percent, this group’s total compensation was 3.2 times larger in 2009 than in 2008, accounting for 0.6 percent of all pay. These 74 people made as much as the 19 million lowest-paid people in America, who constitute one in every eight workers.

Average Median Wages, 1990 to 2009 (in 2009$)

Back in 1994, when the top category the government reported on was $20 million or more of compensation, only 25 people were in that rarefied atmosphere, and their average earnings came to just under $45 million in 2009 dollars.

What does this all mean? It is the latest, and in this case quite dramatic, evidence that our economic policies in Washington are undermining the nation as a whole.We have created a tax system that changes continually as politicians manipulate it to extract campaign donations. We have enabled ""free trade’’ that is nothing of the sort, but rather tax-subsidized mechanisms that encourage American manufacturers to close their domestic factories, fire workers, and then use cheap labor in China for products they send right back to the United States. This has created enormous downward pressure on wages, and not just for factory workers.

Combined with government policies that have reduced the share of private-sector workers in unions by more than two-thirds — while our competitors in Canada, Europe, and Japan continue to have highly unionized workforces — the net effect has been disastrous for the vast majority of American workers. And of course, less money earned from labor translates into less money to finance the United States of America.

This systematic destruction of the working class and middle class has come during an era notable for celebrating the super-rich just for being super-rich. From the Forbes 400 launch in 1982 and Robin Leach’s Lifestyles of the Rich and Famous in 1984 to the faux reality of the multiplying Real Housewives shows, money voyeurism has grown in tandem with stagnant to falling incomes for the vast majority. There has also been huge income growth at the top and the economic children of income inequality: budget deficits and malign neglect of our commonwealth.

This orgy of money exhibitionism has created a society in which commas — it takes three to be a billionaire — count more than character. We have gone so far down this path that we bailed out bankers, allowing them to keep the untaxed wealth in their deferral accounts and, with a few exceptions, retaining shareholder value, while wiping out investors in General Motors and Chrysler as a condition of their bailouts. And while autoworkers had to take severe pay cuts, bonus time on Wall Street is at new record levels.

The American economy in the three decades before Ronald Reagan’s election did not produce a mass audience for celebrating wealth. In that era, books that emphasized character sold better than today. During the years from 1950 to 1980, the share of total income going to those at the top declined, and the real incomes of the vast majority grew much more quickly than did nearly all incomes at the very top. In those years, America had the money, and vision, to invest in the future through education, research, and infrastructure.

In nearly three decades of Reaganism, however, we have become a society of mine-here-and-now. Now what we hear from Washington is about today, not tomorrow. War without sacrifice (or a congressional declaration). Savings without interest. More government services while lowering taxes.

In this era, the incomes of the vast majority have barely grown while incomes at the top have soared. Reaganism has trimmed the base of the income ladder while placing a much heavier weight on the top. Narrowing the base while adding weight to the apex does not make a stable structure. Here are some numbers that may surprise those ages 50 and under, taken from the latest analysis of tax return data by Emmanuel Saez and Thomas Piketty, who have won worldwide praise for their groundbreaking work examining changes in income distribution:

Bottom 90 Percent Income Share Changes

So a three-decade era in which the bottom 90 percent increased their share of all income slightly was followed by a 28-year period at whose end income had fallen sharply. The 2009 data show that it has only gotten worse since then. While the vast majority must get by on a much smaller share of the national income pie, the re-slicing resulted in concentrated benefits at the top. The top 10 percent enjoyed a nearly 40 percent increase in their share of the income pie. But within the top 10 percent, the re-slicing of the income pie between 1980 and 2008 was also heavily weighted to the top.

Those in the 90th to 95th percentile income category saw their income share rise by just 0.24 percentage points. The 95th to 99th income category got 2.43 percentage points more slice of the national income pie. That means that of the 13.59 percentage points of increased pie going to the top 10 percent of Americans, the top 1 percent earned almost 11 percentage points of it. Now look at how the pie was sliced within the top 1 percent:

Income Share Gains, in Percentage Points, in 2008 Over 1980 for Top 1% of Earners

Notice that as you move to the right, the numbers of taxpayers shrink, but the percentage points grow. The theme: more and more for fewer and fewer. Income shares tell us about how groups are doing relative to one another. But you can’t spend income shares, so let’s look at incomes.

From 1950 to 1980, the average income of the bottom 90 percent grew tremendously. Not so since then:

Had income growth from 1950 to 1980 continued at the same rate for the next 28 years, the average income of the bottom 90 percent in 2008 would have been 68 percent higher, instead of just 1 percent more. That would have meant an average income for the vast majority of $52,051, or $21,110 more than actual 2008 incomes. How different America would be today if the typical family had $406 more each week - less debt, more savings, and more consumption.

So how about the top? This is where the changes in incomes in these two eras become interesting, very interesting. What the figures below show is that the closer you got to the top of the ladder in the era from 1950 to 1980, the smaller your relative increase in income, except for the very top, whose gains were slightly more than those of the bottom 90 percent. Since 1980, however, the bottom 90 percent of Americans have seen their incomes go nowhere, while on the highest steps of the income ladder, the further up you are, the greater your gains.

Add in today’s decreased number of jobs, and all these data add up to policies that can be described with one word: failed.

These are short-term bets. Very short. The founder of Tradebot, in Kansas City, Mo., told students in 2008 that his firm typically held stocks for 11 seconds. Tradebot, one of the biggest high-frequency traders around, had not had a losing day in four years, he said

70% of trading volume on the major exchanges is conducted by high-frequency traders who hold a stock for an average of 11 seconds.

The fact that the vast majority of stock market trades are held for 11 seconds shows that the stock market is not a real market with real traders governed by the law of supply and demand, and that there is no real price discovery.

But as Tyler Durden points out, alot can happen in 11 seconds when the players are high-powered computers:

07-29-10BATS "Flag Repeater". 15,000 quotes in 11 seconds, dropping the ASK price 1 penny each quote from $9.36 to $8.58 and back up again.

The abnormal state of the credit markets came into focus as the US Treasury sold bonds with negative interest rates for the first time and Goldman Sachs prepared to issue its first 50-year debt deal. Both developments on Monday highlighted the difficult choices facing investors at a time when interest rates are at historical lows and the Federal Reserve is moving towards more asset purchases aimed at boosting the economy and staving off deflation. Investors who believe the Fed will succeed in its efforts – which would lead to higher inflation – accepted a yield of minus 0.55 per cent on $10bn of Treasury Inflation Protected Securities – or Tips – which compensate holders if the consumer price index rises.

At the same time, retail investors looking for higher yields in the current low interest-rate environment were targeted by Goldman, which prepared to sell $250m of 50-year bonds that are expected to pay interest of up to 6.25 per cent. “The Fed has been sending the message that its cheque book is ready and it will do what it takes to reflate the economy,” said Jan Loeys, head of global asset allocation at JPMorgan Chase. “What no one knows is whether inflation will start to show in two weeks or two years.”

Mr Loeys added: “We are seeing longer-term thinking clients becoming increasingly wary of bonds and hedging against inflation. Shorter-term thinkers are still willing to still buy bonds, on the presumption that they are nimble enough to get out when inflation comes to push yields up.” Long-term institutional buyers purchased 39 per cent of the $10bn Tips sale, up from an average share of 30 per cent for the prior six Tips sales.

The negative rate for Tips is a boon for the Treasury as it lowers its financing costs. But it may herald problems for bondholders in the future, since higher inflation would erode the value of fixed-income securities without inflation protection. Expectations for inflation over the next five years – based on comparing Treasury yields and those for Tips – have risen as high as 1.75 per cent this month, up from 1.13 per cent in August.

Analysts say they doubt the current environment of low nominal Treasury yields and strong demand for Tips with negative rates can last. “If inflation protection is in such strong demand that investors will buy aggressively at negative real yields, then surely at some point investors have to question the wisdom of buying nominal Treasuries with such low yields,” said Richard Gilhooly, strategist at TD Securities. With official interest rates at close to zero per cent, investors also have been buying longer-dated corporate bonds or debt sold by riskier companies in search of higher yields.

Home prices fell 0.2% in August, according to the Case-Shiller home price index released Tuesday by Standard & Poor’s, in a report labelled “disappointing” by its compilers. This is the first drop in the index after four straight monthly gains as demand spiked by the homebuyer tax credit that expired at the end of April. Prices fell in 15 of the 20 metropolitan areas tracked by Case-Shiller in August compared with July. Annualized price growth slowed to 1.7% from 3.2% in July.

Chicago, Detroit, Las Vegas, New York and Washington, D.C. were the only five cities that recorded small improvements in home prices over July. David Blitzer, chairman of the index committee at Standard & Poor’s, called the report “disappointing.” “At this time, it does not seem that any of the markets are hanging on to the temporary momentum caused by the homebuyers’ tax credits,” Blitzer said in a comment that accompanied the report.

Economists are concerned that there may be additional downward pressure on prices as demand slows in cooler months. The expiration of the tax credit combined with the cooler temperatures may create “a downside double-whammy for prices,” Josh Shapiro, chief U.S. economist at MFR Inc, wrote in a research note. On a year-over-year basis, 12 of the 20 metropolitan areas posted negative growth rates. Seventeen of the regions showed a deceleration in growth rates. Only Charlotte, Cleveland and Las Vegas saw improvement in year-over-year growth rates.The Case-Shiller index is based on repeat sales of the same properties.

Lawyers representing delinquent homeowners have been shouting for years about documentation problems in residential mortgages. Now that their complaints have gained traction with investors, attorneys general and some state court officials, the question of consequences looms large. Is the banks’ sloppy paperwork a matter of simple technicalities that are relatively easy to cure, as the banks contend? Or are there more far-reaching consequences for banks and the institutions that bought mortgage-backed securities during the mania? Oddly enough, the answer to both questions may be yes.

According to real estate lawyers, most banks that have gotten into trouble because they didn’t produce proper proof of ownership in foreclosure proceedings can probably cure these deficiencies. But doing so will be costly and time-consuming, requiring banks to comb through every mortgage assignment and secure proper signatures at each step of the way — and it surely will take much longer than a few weeks, as banks have contended.

Once this has been done appropriately (not by robo-signers, mind you) the missing links in the banks’ chain of ownership can be considered complete and individual foreclosures can proceed legally. None of this will be easy, however. And it will be especially challenging when one or more of the parties in the chain has gone bankrupt or been acquired, as is the case with so many participants in the mortgage business.

Still, addressing all of these lapses is possible, according to Joshua Stein, a real estate lawyer in New York. "If there are missing links in your chain of title, you go back to your transferor and get the documents you need," he said in an interview last week. "If the transferor doesn’t exist any more, there are ways to deal with it, though it’s not necessarily easy or cheap. Ultimately, you can go to the judge in the foreclosure action and say: "I think I bought this loan but there is one thing missing. Look at the evidence — you should overlook this gap because I am the rightful owner.’ "

Such an unwieldy process will make it more expensive for banks to overhaul their loan servicing operations to address myriad concerns from judges and regulators, but analysts say it can be done.

On the other hand, resolving paperwork woes in the world of mortgage-backed securities may be trickier. Experts say that any parties involved in the creation, sale and oversight of the trusts holding the securities may be held responsible for any failings — and if the rules weren’t followed, investors may be able to sue the sponsors to recover their original investments. Mind you, the market for mortgage-backed securities is huge — some $1.4 trillion of private-label residential mortgage securities were outstanding at the end of June, according to the Securities Industry and Financial Markets Association.

Certainly no one believes that all of these securities have documentation flaws. But if even a small fraction do, that would still amount to a lot of cabbage. Big investors are already rattling the cage on the issue of inadequate loan documentation. Last week, investors in mortgage securities issued by Countrywide, including the Federal Reserve Bank of New York, sent a letter to Bank of America (which took over Countrywide in 2008) demanding that the bank buy back billions of dollars worth of mortgages that were bundled into the securities. The investors contend that the bank did not sufficiently vet documents relating to loans in these pools.

The letter stated, for example, that Bank of America failed to demand that entities selling loans into the pool "cure deficiencies in mortgage records when deficient loan files and lien records are discovered." Bank of America has rejected the investors’ argument and said that it would fight their demand to buy back loans. Mortgage securities, like other instruments that have generated large losses for investors during the crisis, have extremely complex structures. Technically known as Real Estate Mortgage Investment Conduits, or Remics, these instruments provide investors with favorable tax treatment on the income generated by the loans.

When investors — like the New York Fed — contend that strict rules governing these structures aren’t met, they can try to force a company like Bank of America to buy them back. Which brings us back to the sloppy paperwork that lawyers for delinquent borrowers have uncovered: some of the dubious documentation may undermine the security into which the loans were bundled.

For example, the common practice of transferring a promissory note underlying a property to a trust without identifying it, known as an assignment in blank, may run afoul of rules governing the structure of the security. "The danger here is that the note would not be considered a qualified mortgage," said Robert Willens, an authority on tax law, "an obligation which is principally secured by an interest in real property and which is transferred to the Remic on the start-up day." If, within three months, substantially all the assets of the entity do not consist of qualified mortgages and permitted investments, "the entity would not constitute," he said.

If such failures increase taxes for investors in the trusts, Mr. Willens said, the courts will have to adjudicate the inevitable conflicts that arise. What if a loan originator failed to provide documentation substantiating that what’s known as a "true sale" actually occurred when mortgages were transferred into trusts — documentation that is supposed to be provided no longer than 90 days after a trust is closed? Well, in that situation, a true sale may not have legally happened, and that doesn’t appear to be a problem that can be smoothed over by revisiting and revamping the paperwork.

"The issue of bad assignment has many implications," said Christopher Whalen, editor of the Institutional Risk Analyst. "It does question whether the investor is secured by collateral." In other words, were the loans legally transferred into the trust, and, if not, do the trusts lack collateral for investors to claim? For example, according to a court filing last year by the Florida Bankers Association, it was routine practice among its members to destroy the original note underlying a property when it was converted to an electronic file. This was done "to avoid confusion," the association said.

But because most securitizations state that a complete loan file must contain the original note, some trust experts wonder whether an electronic image would satisfy that requirement. All of this suggests that while a paperwork cure may eventually exist for foreclosures, higher hurdles exist when it comes to remedying flaws in mortgage-backed securities. The only way to wrestle with the latter, some analysts say, is in a courtroom.

"The whole essence of this crisis is fraud and unless we restore the rule of law and transparency of disclosure, we are not going to fix this," said Laurence J. Kotlikoff, an economics professor at Boston University.

They Knew What They Were SellingIt's hard to know where to start. There is just so much here. So let's begin with testimony from Mr. Richard Bowen, former senior vice-president and business chief underwriter with CitiMortgage Inc. This was given to the Financial Crisis Inquiry Commission Hearing on Subprime Lending andnd Securitization andnd Government Sponsored Enterprises. I am going to excerpt from his testimony, but you can read the whole thing (if you have a strong stomach) at http://fcic.gov/hearings/pdfs/2010-0407-Bowen.pdf. (Emphasis obviously mine.)

"The delegated flow channel purchased approximately $50 billion of prime mortgages annually. These mortgages were not underwriten by us before they were purchased. My Quality Assurance area was responsible for underwriting a small sample of the files post-purchase to ensure credit quality was maintained.

"These mortgages were sold to Fannie Mae, Freddie Mac [We will come back to this - JM] and other investors. Although we did not underwrite these mortgages, Citi did rep and warrant to the investors that the mortgages were underwritten to Citi credit guidelines.

"In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets. This situation represented a large potential risk to the shareholders of Citigroup.

"I started issuing warnings in June of 2006 and attempted to get management to address these critical risk issues. These warnings continued through 2007 and went to all levels of the Consumer Lending Group.

"We continued to purchase and sell to investors even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production."

Mr. Bowen was no young kid. He had 35 years of experience. He was the guy they hired to pay attention to the risks, and they ignored him. How could a senior manager not get such an email and not notify his boss, if only to protect his own ass? They had to have known what they were selling all the way up and down the ladder. But the music was playing and Chuck Prince said to dance and rake in the profits (and bonuses!). More from his testimony:

"Beginning in 2006 I issued many warnings to management concerning these practices, and specifically objected to the purchase of many identified pools. I believed that these practices exposed Citi to substantial risk of loss.

Warning to Mr. Robert Rubin and Management"On November 3, 2007, I sent an email to Mr. Robert Rubin and three other members of Corporate Management... In this email I outlined the business practices that I had witnessed and attempted to address. I specifically warned about the extreme risks that existed within the Consumer Lending Group. And I warned that there were 'resulting significant but possibly unrecognized financial losses existing within Citigroup.'"

And now taxpayers own 75% of Citi, and our losses to them are huge. They are going to get worse, as we will see.

Now let's turn to the testimony of Keith Johnson, who worked for various mortgage companies and in 2006 became the president and chief operating officer of Clayton Holdings, the largest residential loan due diligence and securitization surveillance company in the United States and Europe. This is testimony he gave before the Financial Crisis Inquiry Commission. Part of the testimony is by his associate Vicki Beal, senior vice-president of Clayton. The transcript is some 277 pages long, so let me summarize.

Investment banks would come to Clayton and give then roughly 10% of the mortgages that they intended to buy and put into a security. Clayton rated them on whether the documentation was what it was supposed to be, not as to whether they thought it was a good loan. Still, 46% of the loans did not have proper documentation (out of a pool of 9 million loans) and 28% had what was determined to be level 3 disqualifications that simply had no mitigating circumstances. Understand, these were loans that were already written, and there was no effort to check the facts, just the documentation.

And ultimately 11% of these loans (39% of the level 3's) were put back in by the investment bank. And what happened to the loans that were rejected? (This might require an adult beverage and a few expletives deleted.)

Popping ThroughThey were put back into another pool, where again only 10% of the loans were examined. Quoting from the testimony:

"MR. JOHNSON: I think it goes to the 'three strikes, you're out' rule.

"CHAIRMAN ANGELIDES: So this was a case of - okay, three strikes.

"MR. JOHNSON: I've heard that even used. Try it once, try it twice, try it three times, and if you can't get it out, then put -

"CHAIRMAN ANGELIDES: Well, the odds are pretty good if you are sampling 5 to 10 percent that you'll pop through. When you said the good, the bad, the ugly, the ugly will pop through."

Yes, you read that right. If a loan was rejected a second time, it went back into yet another pool for a third try. The odds of coming up three times, when only 5 or 10 percent are sampled? About 1 in a thousand. Popping through, indeed.

Clayton presented their data to the ratings agencies, investment banks, and others in the industry. They were frustrated that no one was really paying attention or taking heed of their warnings.

"Johnson told the crisis panel that he thought the firm's findings should have been disclosed to investors during this period. He added that he saw one European deal mention it, but nothing else.

"The firm's findings could have been 'material,' Johnson said, using a legal adjective that could determine cause or affect a judgment.

"It's unclear whether the firms ended up buying all of those loans, or whether Wall Street securitized them all and sold them off to investors.

"'Clayton generally does not know which or how many loans the client ultimately purchases,' Beal said. That likely will be the subject of litigation and investigations going forward.

"'This should have a phenomenal effect legally, both in terms of the ability of investors to force put-backs and to sue for fraud,' said Joshua Rosner, managing director at independent research consultancy Graham Fisher & Co.

"'Original buyers of these securities could sue for fraud; distressed investors, who buy assets on the cheap, could force issuers to take back the mortgages and swallow the losses.

"'I don't think people are really thinking about this,' Rosner said. 'This is not just errors and omissions - this appears to be fraud, especially if there is evidence to demonstrate that they went back and used the due diligence reports to justify paying lower prices for the loans, and did not inform the investors of that."

"Beal testified that Clayton's clients use the firm's reports to 'negotiate better prices on pools of loans they are considering for purchase,' among other uses.

"Nearly $1.7 trillion in securities backed by mortgages not guaranteed by the government were sold to investors during those 18 months, according to Inside Mortgage Finance. Wall Street banks sold much of that. At its peak, the amount of outstanding so-called non-agency mortgage securities reached $2.3 trillion in June 2007, according to data compiled by Bloomberg. Less than $1.4 trillion remain as investors refused to buy new issuance and the mortgages underpinning existing securities were either paid off or written off as losses, Bloomberg data show.

"The potential for liability on the part of the issuer 'probably does give an investor more grounds for a lawsuit than they would ordinarily have', Cecala said. 'Generally, to go after an issuer you really have to prove that they knowingly did something wrong. This certainly seems to lend credibility to that argument.'

"'This appears to be a massive fraud perpetrated on the investing public on a scale never before seen,' Rosner added."

Basically, if buyers of 25% or more of a mortgage-backed security can come together, they have standing to sue the mortgage servicer to do its duty to the investors and make putbacks of bad mortgages, and if they fail to do so the plaintiffs can take control of the process and take the issuer to court directly (that's a very simplistic description but roughly accurate).

There are two key take-aways. First, note that a European entity is involved. Hundreds of billions of dollars of this junk was sold to European banks and funds. And these guys get together at conferences (sometimes they even invite me to speak). So Helmut will be talking to Lars who will talk to Jean Pierre and they will realize they all own some of this junk. They will be watching with very real interest to see how the big boys at PIMCO and Black Rock and the New York Fed fare in their efforts. And then you can count on them all piling on (more later on this).

Second, little noticed this week was the fact that The Litigation Daily wrote that Philippe Selendy of Quinn Emanuel Urquhart & Sullivan has been retained by the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae and Freddie Mac, to investigate billions of dollars in potential claims against banks and other issuers of mortgage-backed securities.

Who? Not on your celebrity list? Just wait. He will soon be getting the best tables everywhere. He and his firm are the guys representing MBIA in all their cases against Countrywide and Merrill Lynch. And they are kicking ass. Slowly to be sure, but very steady. That means Fannie and Freddie are getting ready to get serious.

They were sold well over $227 billion of the subprime garbage issued in 2006 and 2007. And the bad stuff started before then. But they have one advantage that the guys at PIMCO, et al. don't have: they (or actually the FHFA) are a federal agency. That means they have subpoena power. The agency has sent 64 subpoenas to issuers of mortgage-backed securities, and although they have not said who they went to, they obviously include almost everyone and clearly all the big players. (They couldn't have ignored Goldman, could they? Naah. Too obvious.)

From American Lawyer.com (I know, this website is probably already on your favorites list, but for those souls who actually have a life I provide the text):

"Through those subpoenas, the agency could gain access to the loan files for the mortgages that backed the securities it bought and thus establish whether the mortgages were what the issuers represented them to be in securities contracts. According to the Journal, the difficulty of obtaining loan files has been a big obstacle for investors trying to force issuers to repurchase bonds.

"If the FHFA were to decide down the road to initiate litigation, it would still have to have the support of a percentage (usually 25 percent) of its fellow bondholders for each issue. But given what the agency and its Quinn lawyers will be able to see before bringing suit, it probably won't be too hard to get other investors on the bandwagon." ( PDF here)

It is tough not to jump to the conclusion, but we need one more piece of the puzzle before we get there.

The Worst Deal of the Decade?Arguably Bank of America had Merrill shoved down their throats, but no one can say that about the acquisition of Countrywide. And Countrywide could end up costing BAC $50 billion or more in losses. That may prove to be a serious candidate for worst deal of the decade. (Although WAMU is a leading candidate too!)

Let's look at a report by Branch Hill Capital, a hedge fund out of San Francisco. And before we start on it, let me point out they are short Bank of America. You can see the full PowerPoint here.

(And let me say a big thanks to the author of the report, Manal Mehta, for all the background material he sent me and his help with this week's letter. It helped make it a lot better. Of course, any erroneous conclusions or outrageous statements are all mine.)

First, they point out that the potential size of Bank of America's (BAC) liabilities is $74 billion (with a B). And that is just for Countrywide. That does not include Merrill, which is also large. Against that they have set aside $3.9 billion. You can count on more suits than just the PIMCO, et al. mentioned above.

In the MBIA case, the judge has ruled that the suit can proceed even though BAC has denied responsibility. Although on appeal, this is high-stakes poker. Countrywide originated over $1.4 trillion of mortgages in 2005-2007. MBIA alleges that over 90% of the defaulted or delinquent loans in the Countrywide securitizations show material discrepancies. Care to take the under in the over/under bet on that?

Further to the case on BAC, Merrill was the largest originator of subprime CDOs during the housing boom, for another $120 billion, along with about $255 billion of residential mortgage-backed securities.

And then there are all those CDOs (collaterized debt obligations). Merrill did a lot of those that went sour. This deserves it own leter, but a gentleman named Wing Chau went from making $140k a year to $25 million in just a few years, putting together CDOs from Merrill, some of which were completely bankrupt in just six months.

Countrywide has already settled with the New York pension funds for $624 million, one of the largest securities fraud settlements in US history. And the line is growing longer.

Of course, BAC CEO Brian Moynihan denied this week that there is a problem. Let's look at Moynihan's statements at the last earnings call and compare them to what the judge in the case said earlier. Moynihan:

"... we execute repurchases on a loan by loan basis... And as we learn more, and again, our perspective on this - we're going to be quite diligent as I said in defending the interest of our shareholders. This really gets down to a loan-by-loan determination and we have, we believe, the resources to deploy against that kind of a review."

Back in June the judge on the case (a Judge Bransten) said (from the transcript):

"I think that it makes all the sense in the world that you can use a sample to prove the case because otherwise I can't imagine a jury listening to 386 thousand cases. Even if you have that available, nevertheless you are not going to present that to a jury or even to a judge. I'm patient but not that patient. So therefore it is going to be a sample in the end..."

OK, let me get this straight, Brian. Your company committed fraud, with robosignings and all the rest, and you won't man up and take responsibility? You and your lawyers want to thrash this out, case by case, fighting a trench-warfare, rear-guard action? Well I'm afraid that's not going to work out for you. There are so many examples of Countrywide outright fraud that it is going to be hard to convince a jury that BAC is not on the hook. Will it take years? Of course.

You can read the PowerPoint for details. Bottom line: BAC is probably liable for putbacks that could total over a hundred billion. And that is just BAC.

Think Citi. And any of the scores of mortgage originators and investment banks. There were a couple of trillion dollars in these securitizations issued. Plus how many hundred of billions of second-lien loans? And can we forget CDOs? And CDOs squared?

And let's not forget all those completely synthetic CDOs that were written at the height of the mania. Most of it AAA, of course. Frankly, anyone stupid enough to buy a synthetic CDO should lose their money, but that is not what the courts will base their decision on. It is all about representations and warranties. And maybe a little fraud.

I picked on BAC because that is the analysis I saw. But it could be any of dozens of banks. Look at this list from the Branch Hill PowerPoint.

Could we see a hundred billion in losses to the major banks? In my opinion we will for sure, over time. $200 billion? Probably. $300 billion? Maybe. $400 billion? It depends on how organized the investors in the securities get and what gets settled out of court. Out of a few trillion dollars in securitizations? It's anybody's guess. I just made mine.

But let's not forget the $227 billion sold to Fannie and Freddie. Taxpayers are on the hook for $300-400 billion in losses. Those putbacks could save us a lot. Will this threaten the viability of some banks? Maybe. But most will survive. BAC made $3 billion last quarter. A steep yield curve (with the help of the Fed) can cure a lot of evils. But it will absorb the profits of a lot of banks for a long time.

And that of course, will come back to haunt the rest of us as banks have to raise more capital and get more conservative.

Anyone who owns stocks in banks with relatively large MBS exposure is not investing, they are gambling that the losses will not be more than management is telling them. There will be no bailouts (at least I hope not) this time around. Fool me once, shame on you; fool me twice, shame on me. There will be little sympathy for shareholders or bondholders this time, if it comes to that.

One more sad point. The FDIC (read taxpayers) is liable for some of this, as they took over some of these institutions. It just keeps on coming.

Final rant. If you were part of a group that knowingly created or sold flawed and fraudulent mortgage-backed securities to pensions and insurance companies and took home tens of millions in bonuses, up and down the management chain, maybe you should consider moving yourself and your money to a country that does not honor US extradition, because my guess is that, as all this comes out, you may have to hire some very expensive lawyers and get measured for pinstripes.

And the Mozilo agreement was a sham. Sigh. That would be the equivalent of fining me $10,000 and letting me keep my tanning bed. I don't have the space to go into the fraud at Countrywide, but their internal documents show they all knew what was going on.

The late Bloomberg News reporter Mark Pittman asked the U.S. Treasury in January 2009 to identify $301 billion of securities owned by Citigroup Inc. that the government had agreed to guarantee. He made the request on the grounds that taxpayers ought to know how their money was being used. More than 20 months later, after saying at least five times that a response was imminent, Treasury officials responded with 560 pages of printed-out e-mails -- none of which Pittman requested. They were so heavily redacted that most of what’s left are everyday messages such as "Did you just try to call me?" and "Monday will be a busy day!"

None of the documents answers Pittman’s request for "records sufficient to show the names of the relevant securities" or the dates and terms of the guarantees. Even so, the U.S. government considers the collection of e-mails a partial response to an official request under the federal Freedom of Information Act, or FOIA. The Justice Department in July cited an increase in such responses as evidence that "more information is being released" under the law. President Barack Obama vowed to usher in a new era of open government. On Jan. 21, 2009, the day after his inauguration and a week before Pittman submitted his FOIA request, Obama directed agencies to "adopt a presumption in favor of disclosure, in order to renew their commitment to the principles embodied in FOIA."

Limits of TransparencyThe saga of Pittman’s request shows that the promise of transparency has its limits when it comes to the government’s intervention in the financial industry, which at its peak reached $12.8 trillion in commitments. From the 2008 Bear Stearns Cos. rescue to the Federal Reserve’s policy of quantitative easing in 2010, the Obama administration has delayed disclosures and defended its right to secrecy in court, said Tom Fitton, president of Judicial Watch Inc., which describes itself as a conservative foundation.

"This is an unprecedented crisis for open government," said Fitton, whose Washington-based organization says it sued the Bush administration 48 times over disclosure issues. "When it comes to the bank bailout, the Obama administration has made a decision to err on the side of secrecy." The Justice Department, which oversees disclosure for the executive branch, is "working specifically to encourage agencies to be as transparent as possible and release as much as possible," said Melanie Ann Pustay, director of the department’s Office of Information Policy. "We view our efforts as an ongoing process."

Openness Aids RecoveryMore openness concerning the causes of the crisis and the government’s response would help the economy recover, said Joseph Mason, a finance professor at the Ourso College of Business at Louisiana State University in Baton Rouge. "Investors who don’t have information are investors who refuse to place funds in markets," Mason said. "If we want investment and economic growth to resume, we want to be forthright about what happened. The longer we keep investors in the dark, the longer that low economic growth will persist."

The public has a particular interest in transparency regarding the government’s unprecedented intervention in capital markets because of its sheer size, said U.S. Representative Darrell Issa of California, the ranking Republican on the Committee on Oversight and Government Reform. He called the Obama administration "woefully inadequate" at fulfilling its promise of transparency. "At a time when the role of government and more specifically the Treasury Department, through bailouts and stimulus, is responsible for administering trillions of dollars, there couldn’t be a more important time to uphold the American people’s right to know," Issa said in an e-mail.

On Jan. 28, 2009, Pittman asked Treasury officials for details related to guarantees the agency had provided on securities held by Citigroup, American International Group Inc. and Bank of America Corp. Among other things, he asked for any contracts with outside firms hired to calculate the assets’ values. In its response, Treasury said AIG didn’t participate in its Asset Guarantee Program. Likewise, despite some negotiations, the government and Charlotte, North Carolina-based Bank of America "never entered into a definitive agreement," the response said.

Citigroup’s Largest ShareholderThat left Citigroup, in which the U.S. government was the largest shareholder as of Oct. 1, according to regulatory filings. Taxpayers’ stake, 12.4 percent, was three times the second-largest investor’s. In the 560 pages of e-mails exchanged in the last two months of 2008 and January 2009, Treasury employees and their colleagues at the Federal Reserve Bank of New York discuss with attorneys the department’s $20 billion investment in New York- based Citigroup and the $301 billion in guarantees. Both followed an initial $25 billion investment in Citigroup through the Troubled Asset Relief Program in October 2008.

The Treasury Department also released 169 pages that included a "Securities Purchase Agreement" between the bank, the agency and the Federal Deposit Insurance Corp. The document had previously been disclosed in a Jan. 16, 2009, Citigroup regulatory filing -- almost two weeks before Pittman sent his request. The department held back 866 more pages, saying each was exempt from disclosure on one of four grounds: trade secrets, personnel rules and practices, memos subject to attorney-client privilege and violations of personal privacy.

Treasury also cited the trade-secrets exemption in responding to a separate, similar FOIA request by Bloomberg News for details about Citigroup’s segregated bad assets. In that response, 73 of 104 pages were completely blacked out except for headings. Only six pages -- the cover, contents, a boilerplate list of legal disclosures and a paragraph titled "FOIA Request for Confidential Treatment" -- were free of redactions.

The department’s reply to Pittman’s request will count statistically as a "partial response," in government reports, said Hugh Gilmore, Treasury’s FOIA public liaison. The response "adhered to the rules, regulations, U.S. attorney general guidance and relevant case law that govern FOIA," Steven Adamske, a Treasury spokesman, said in an e-mail.

Right of AppealPeople who aren’t satisfied with federal agencies’ responses under FOIA can appeal to them first, and then file civil lawsuits in U.S. District Court to try to force more disclosure. Bloomberg LP, the parent company of Bloomberg News, sued the Fed over another Pittman FOIA request that sought the names of banks that took emergency loans from the central bank. The company has prevailed in U.S. District Court and on appeal. The Fed, which has not released the information, has until tomorrow to decide whether to ask the U.S. Supreme Court to consider the case.

Like the Treasury Department, the central bank cited the exemption for trade secrets, known as exemption 4, in withholding details about borrowers. Its lawyers argued that disclosing the banks’ identities would put the institutions at a competitive disadvantage and make them less likely to seek emergency loans in the future.

In an Aug. 24, 2009, ruling, Chief U.S. District Judge Loretta A. Preska in Manhattan disagreed. "The risk of looking weak to competitors and shareholders is an inherent risk of market participation; information tending to increase that risk does not make the information privileged or confidential," Preska wrote. The Fed "would seemingly sweep within the scope of Exemption 4 all information about borrowers that anyone throughout the entire marketplace might consider to be negative. The exemption cannot withstand such inflation."

Pittman’s request for the Treasury Department records spent months in limbo, according to discussions with the agency’s employees. He had waited about 10 months for a response when he died on Nov. 25, 2009. Shortly afterward, Michael Galleher, an attorney working on contract for the Treasury Department, called Bloomberg News, asking where he could send the responsive documents. Attempts to return Galleher’s call failed; he couldn’t be found at the agency.

A December call to Gilmore, the FOIA liaison, was returned by Daneisha White, a FOIA officer, who suggested calling Michael C. Bell, the FOIA manager in the Office of Financial Stability. Bell referred questions back to Gilmore. Meanwhile, that month, Citigroup repaid $20 billion of its bailout money and terminated the asset guarantees.

Searching for RecordsGilmore called back in January, saying Galleher had left the agency at the end of 2009. He and his colleagues would search for Pittman’s FOIA documents, he said, because they weren’t sure where they were. In April came a call from Galleher. He said that he had returned to work at Treasury’s FOIA office, that he had the relevant documents for Pittman’s request and that he would send them that week. "I need to clear the old requests," he said.

The office where Gilmore works, which has the equivalent of 26 fulltime employees, handled 890 FOIA requests in fiscal 2009, according to Treasury’s annual FOIA report to the attorney general. It had 1,766 requests pending at year’s end. Government bureaucracies often aren’t staffed enough to respond adequately to requests for public records, said Lucy Dalglish, executive director of the Reporters Committee for Freedom of the Press in Arlington, Virginia. In addition, she said, they’re simply not motivated to disclose. "Agencies get in far more trouble for releasing information than they do for not," she said. "Am I disappointed in the Obama administration? Yeah."

In May, Galleher reported that he would have something to send soon. He said the same thing in June, and then in July. Part of the holdup was caused by the governmentwide practice of giving private companies a chance to object to the disclosure of requested documents, he said. Doing so ensures that companies continue to cooperate with the executive branch by providing records without fear they’ll be made public without review, said Pustay of the Justice Department.

Neither Citigroup nor the Treasury Department would discuss which redactions, if any, the bank sought on Pittman’s request. Shannon Bell, a spokeswoman for the bank, declined to comment. "We have no obligation to explain how much of Citi’s recommendations we accepted and in what ways we decided to differ," Adamske, the Treasury spokesman, said in an e-mail. Second-guessing the government’s response to the financial crisis is not useful, said Wilbur Ross, the New York billionaire who runs the private-equity firm WL Ross & Co.

"As far as I can tell, there is no evidence of any impure motivation in connection with any of the big decisions," Ross said in an e-mail. "To me that is the issue, not whether you or I would have come to the same conclusion."

Bank of America Corp. for the first time acknowledged finding some mistakes in foreclosure files as it begins to resubmit documents in 102,000 cases. The Charlotte, N.C., lender discovered errors in 10 to 25 out of the first several hundred foreclosure cases it examined starting last Monday. The problems included improper paperwork, lack of signatures and missing files, said people familiar with the results. In certain cases, information about the property and payment history didn't match.

Some of the defects seem relatively minor, according to the bank, and bank officials said they haven't uncovered any evidence of wrongful foreclosures. There was an address missing one of five digits, misspellings of borrowers' names, a transposition of a first and last name and a missing signature on one document "underlying" an affidavit, a bank spokesman said.

But the bank uncovered these mistakes while preparing less than 1% of the first foreclosure files that it intends to resubmit to the courts in 23 states. As the nation's largest mortgage lender, the bank is under pressure to show that its mortgage process isn't flawed amid revelations that many banks used "robo-signers" to approve large numbers of foreclosure documents without reading them closely. State and federal agencies launched investigations into the allegations, and some officials, including Iowa's attorney general, said they wouldn't necessarily trust the banks' self-assessments.

Several statements from bank officers about foreclosure practices have come under scrutiny. Wells Fargo & Co. Chief Executive John Stumpf on Oct. 20 said: "I don't know how other companies do it, but in our company the affidavit signer and the reviewer are the same team member." Days later a deposition emerged from a bankruptcy case indicating that Wells Fargo had in fact used a robo-signer who didn't verify documents she approved. A Wells Fargo spokeswoman said "we don't believe any of those cases or depositions should be taken out of context. If we find some errors and need for improvements we will take that action."

Bank of America in several recent public comments about the foreclosure issue hadn't previously acknowledged even minor errors. Yet last week it uncovered a group of mistakes as it prepared to resubmit the first batch of documents and shared the information internally, according to people familiar with the matter. Executives are briefed twice daily about what was found.

When the bank announced Oct. 18 that it would lift a freeze on foreclosure sales in 23 states, it emphasized the accuracy of its internal review. "Our initial assessment findings show the basis for our foreclosure decisions is accurate," the company said in a statement.

That conclusion, it turns out, was based on an earlier sample of fewer than 1,000 files. The bank found no mistakes in the sample, a spokesman said, but it decided to make changes to its affidavit approval procedures before going through all 102,000 cases. Now, for example, a notary will sit next to the signer of the affidavit as the documents are being reviewed.

The day after the bank began its comprehensive review of all documents, CEO Brian Moynihan told analysts on an Oct. 19 conference call that "the teams reviewing the data have not found information which was inaccurate, which would affect the plain facts of the foreclosure" such as whether the customer was actually delinquent on the loan. The errors uncovered so far support Mr. Moynihan's statement, bank officials said, and all mistakes are being corrected before the bank resubmits documents to the courts.

Barbara Desoer, president of home loans for Bank of America, said Sunday that Mr. Moynihan's Oct. 19 comments were "consistent" with the review findings. "The basis for the foreclosure decisions have been accurate and correct," she said.

Thousands of foreclosures across the city are in question because paperwork used to justify the seizure of homes is riddled with flaws, a Daily News probe has found. Banks have suspended some 4,450 foreclosures in all five boroughs because of paperwork problems like missing and inaccurate documents, dubious signatures and banks trying to foreclose on mortgages they don't even own.

The city's not alone. All 50 states are investigating foreclosure paperwork, evicted homeowners are hiring lawyers and buyers of foreclosed homes are fretting over the legality of their purchases.Last week, New York's top judge, Jonathan Lippman, began requiring all bank lawyers to sign a form vouching for the accuracy of their foreclosure paperwork.

That could have been a problem for one Long Island foreclosure that was being brought by GMAC Mortgage last year. A sworn affidavit dated March 30 was signed by someone identified as Sherry Hall, vice president of a GMAC affiliate called Homecomings Financial Network. Fifteen days later another sworn affidavit surfaced in another Suffolk County foreclosure, this time signed by a GMAC vice president named Sheri D. Hall. Despite the difference in the names, the signatures were identical - and were vouched for by the same notary.

Suffolk Supreme Court Justice Peter Mayer refused to approve the foreclosure bearing the name Sherry Hall and ordered her, and the notary, to appear in court Nov. 17. GMAC officials did not return calls."It's nice to know someone in authority is looking at the fine print," said Derek McCoy, the delinquent homeowner in the case who's trying to keep his Coram home with a loan modification. Mayer issued his decision Sept. 21, the day after GMAC, which was rescued from failure with a $17 billion taxpayer bailout, suspended foreclosures in the 23 states where court approval is required, including New York.

The moratorium, which ended last week, came after GMAC "robo-signer" Jeffrey Stephan admitted in a Maine case he'd signed 10,000 foreclosure documents a month without reviewing them. Stephan also robo-signed in New York. The News found six Bronx foreclosures with his signature, including five in one month. In one case, a judge halted foreclosure on an E. 242nd St. property because Stephan's affidavit did not include supporting documents. The case resumed after GMAC submitted the documents - and a new affidavit.

'Murky' mortgage landscapeJudges are also seeing banks foreclosing on homes they don't yet own - a problem that concerns Brooklyn Supreme Court Justice Arthur Schack. Schack said it's become increasingly "murky" trying to determine who holds a mortgage at the time of foreclosure because they're often passed from one lender to another. At a state Senate committee hearing last year, Schack testified that the lender must prove it holds the mortgage on the day the foreclosure is filed. "Sounds simple, but unfortunately it's not so simple at times," he said.

Last August, Schack dismissed a foreclosure the Bank of New York was bringing on an E. 48th St. home in Brooklyn that was filed 61 days before the mortgage was assigned to the bank. The judge dubbed as "nonsensical" a computer printout the bank claimed proved it held the mortgage before the foreclosure was brought. In May, Schack rejected a lawyer's claim that the assignment of the mortgage on a Jefferson St. home in Bushwick to HSBC was valid. "Counsel appears to be operating in a parallel mortgage universe, unrelated to the real universe," he said.

He shot down yet another foreclosure on a Rockaway Parkway home in Brooklyn because JPMorgan Chase couldn't prove it held the mortgage until 75 days after the proceedings began. "The banks have a lot of bright people who are smart, so they should know better," said Edward Roberts, lawyer for one of the homeowners in that case. Last year, Schack tossed a foreclosure that involved a woman who claimed to be many things. On one foreclosure, she swore she was an assistant vice president for a bank, and also an official for a lenders' clearing house. In another, she was an assistant vice president for yet another institution. "She is a milliner's delight by virtue of the number of hats she wears," the judge quipped.

Some banks also pursue foreclosures even after delinquent homeowners have sold the houses and paid off the mortgages. Schack told The News he expects to see more paperwork snafus. "It's like an onion we keep peeling," he said. "It seems to be layers and layers of problems."

Bank of America and GMAC are firing up their formidable foreclosure machines again today, after a brief pause. But hard-pressed homeowners like Lydia Sweetland are asking why lenders often balk at a less disruptive solution: short sales, which allow owners to sell deeply devalued homes for less than what remains on their mortgage.

Ms. Sweetland, 47, tried such a sale this summer out of desperation. She had lost her high-paying job and drained her once-flush retirement savings, and her bank, GMAC, wouldn’t modify her mortgage. After seven months of being unable to pay her mortgage, she decided that a short sale would give her more time to move out of her Phoenix home and damage her credit rating less than a foreclosure.

She owes $206,000 and found a buyer who would pay $200,000. Last Friday, GMAC rejected that offer and said it would foreclose in seven days, even though, according to Ms. Sweetland’s broker, the bank estimates it will make $19,000 less on a foreclosure than on a short sale. "I guess I could salute and say, "O.K., I’m walking, here’s the keys,’ " says Ms. Sweetland, as she sits in a plastic Adirondack chair on her patio. "But I need a little time, and I don’t want to just leave the house vacant. I loved this neighborhood." GMAC declined to be interviewed about Ms. Sweetland’s case.

The halt in most foreclosures the last few weeks gave a hint of hope to homeowners like Ms. Sweetland, who found breathing room to pursue alternatives. Consumer advocates took the view that this might pressure banks to offer mortgage modifications on better terms and perhaps drive interest in short sales, which are rising sharply in many corners of the nation. But some major lenders took a quick inventory of their foreclosure practices and insisted their processes were sound. They now seem intent on resuming foreclosures. And that could have a profound effect on many homeowners.

In Arizona, thousands of homeowners have turned to short sales to avoid foreclosures, and many end up running a daunting procedural gantlet. Several of the largest lenders have set up complicated and balky application systems. Concerns about fraud are one of the reasons lenders are so careful about short sales. Sometimes well-off homeowners want to portray their finances as dire and cut their losses on a property. In other instances, distressed homeowners try to make a short sale to a relative, who would then sell it back to them (a practice that is illegal). A recent industry report estimates that short sale fraud occurs in at least 2 percent of sales and costs banks about $300 million annually.

Short sales are also hindered when homeowners fail to forward the proper papers, have tax liens or cannot find a buyer. Because of such concerns, homeowners often are instructed that they must be delinquent and they must apply for a modification first, even if chances of approval are slim. The aversion to short sales also leads banks to take many months to process applications, and some lenders set unrealistically high sales prices — known as broker price opinions — and hire workers who say they are poorly trained.

As a result, quite a few homeowners seeking short sales — banks will not provide precise numbers — topple into foreclosure, sometimes, critics say, for reasons that are hard to understand. Ms. Sweetland and her broker say they are confounded by her foreclosure, because in Arizona’s depressed real estate market, foreclosed homes often sit vacant for many months before banks are able to resell them. "Banks are historically reluctant to do short sales, fearing that somehow the homeowner is getting an advantage on them," said Diane E. Thompson, of counsel to the National Consumer Law Center. "There’s this irrational belief that if you foreclose and hold on to the property for six months, somehow prices will rebound."

Homeowners, advocates and realty agents offer particularly pointed criticism of Bank of America, the nation’s largest servicer of mortgages, and a recipient of billions of dollars in federal bailout aid. Its holdings account for 31 percent of the pending foreclosures in Maricopa County, which includes Phoenix and Scottsdale, according to an analysis for The Arizona Republic. The bank instructs real estate agents to use its computer program to evaluate short sales. But in three cases observed by The New York Times in collaboration with two real estate agents, the bank’s system repeatedly asked for and lost the same information and generated inaccurate responses.

In half a dozen more cases examined by The New York Times, Bank of America rejected short sale offers, foreclosed and auctioned off houses at lower prices. "When I hear that a client’s mortgage is held by Bank of America, I just sigh. Our chances of getting an approval for them just went from 90 percent to 50-50," said Benjamin Toma, who has a family-run real estate agency in Phoenix. A Bank of America spokeswoman said in an e-mail that the bank had processed 61,000 short sales nationwide this year; she declined to provide numbers for Arizona or to discuss criticisms of the company’s processing.

Fannie Mae, the mortgage finance company with federal backing, gives cash incentives to encourage servicers, who are affiliated with banks and who oversee great bundles of delinquent mortgages, to approve short sales. But less obvious financial incentives can push toward a foreclosure rather than a short sale. Servicers can reap high fees from foreclosures. And lenders can try to collect on private mortgage insurance.

Some advocates and real estate agents also point to an April 2009 regulatory change in an obscure federal accounting law. The change, in effect, allowed banks to foreclose on a home without having to write down a loss until that home was sold. By contrast, if a bank agrees to a short sale, it must mark the loss immediately. Short sales, to be sure, are no free ride for homeowners. They take a hit to their credit ratings, although for three to five years rather than seven after a foreclosure. An owner seeking a short sale must satisfy a laundry list of conditions, including making a detailed disclosure of income, tax and credit liens. And owners must prove that they have no connection to the buyer.

Still, bank decision-making, at least from a homeowner’s perspective, often appears arbitrary. That is certainly the view of Nicholas Yannuzzi, who after 30 years in Arizona still talks with a Philadelphia rasp. Mr. Yannuzzi has owned five houses over time, without any financial problems. When his wife was diagnosed with bone cancer, he put 20 percent down and bought a ranch house in North Scottsdale so that she would not have to climb stairs.

In the last few years, his wife died, he lost his job and he used his retirement fund to pay his mortgage for five months. His bank, Wells Fargo, denied his mortgage modification request and then his request for a short sale. The bank officer told him that Fannie Mae, which held the mortgage, would not take a discount. At the end of last week, he was waiting to be locked out of his home. "I’m a proud man. I’ve worked since I was 20 years old," he said. "But I’ve run out of my 79 weeks of unemployment, so that’s it." He shrugged. "I try to keep in the frame of mind that a lot of people have it worse than me."

Back in Phoenix, Ms. Sweetland’s real estate agent, Sherry Rampy, appeared to receive good news last week. GMAC re-examined her client’s application and suggested it might be approved. But the bank attached a condition: Ms. Sweetland must come up with $2,000 in closing costs or pay $100 a month for 50 months to the bank. Ms. Sweetland, however, is flat broke. A late afternoon desert sun angles across her Pasadena neighborhood. "After this, I’ll never buy again," Ms. Sweetland says. "This is not the American dream. This is not my American dream."

The foreclosure process in the US is slowing, enabling delinquent borrowers to stay in their homes for months after they stop making mortgage payments, according to one of the largest lenders. Freddie Mac, one of the two government-owned entities that finance about half all US mortgages, says that homes are taking as long as eight months to work their way through its foreclosure pipeline, two months longer than was typical before the housing crisis began.

The delay is the result of more borrowers staying in their homes for months after foreclosure proceedings have begun, requiring Freddie Mac to evict them before it can put those homes back on the market. Fannie Mae, the other government-owned mortgage finance company, declined to say how long its process took.

A record number of foreclosures is contributing to the slowdown, but so are mounting legal questions surrounding bank procedures to repossess homes from delinquent borrowers. Some 6.7m homes are either in some stage of delinquency or foreclosure, and nearly 30 per cent of all home sales are of distressed properties, according to Core Logic, a real estate data tracker. In some hard hit markets, such as Phoenix, Arizona, the number is far higher.

"People understand that it’s difficult for lenders to get them out of their homes, and so they are staying longer," said Mark Zandi, of Moody’s economy.com. "In the past, if you got an eviction notice, you were likely to leave quickly. Now people are staying until there is a sheriff at their door."

Some sheriffs are refusing to evict homeowners, following disclosures in court depositions that banks flouted state laws by filing thousands of foreclosure documents without verifying the accuracy of the information they contained. A Chicago-area sheriff has ordered deputies to stop carrying out foreclosure evictions over concerns that banks may be reclaiming properties from the wrong people.

In the case of Freddie Mac and Fannie Mae, which together sit on more than 190,000 foreclosed properties, the process of getting distressed homes ready for resale can take months and cost millions of dollars. If borrowers still occupy the homes, Freddie Mac will offer them financial assistance with relocation, a programme known as "cash for keys". Eviction proceedings are a last resort.

Some borrowers are wise to these delays. Shasta Gaughen has not made a payment on her California apartment since February, but Bank of America, which owns the loan, has not forced her out. "I imagine that they will let me stay for quite some time," she said.

The Obama administration's signature anti-foreclosure effort, unveiled in 2009 with the promise of helping three to four million homeowners modify their mortgages, is such a failure that it now risks "generating public anger and mistrust," according to a federal audit released Monday.

Far from helping at-risk homeowners, the Home Affordable Modification Program has actually made some homeowners worse off, according to the Special Inspector General for the Troubled Asset Relief Program -- also known as the Wall Street bailout. The Treasury Department set aside $50 billion from TARP, plus another $25 billion from taxpayer-owned Fannie Mae and Freddie Mac, to give mortgage servicers thousand-dollar incentives to reduce monthly mortgage payments by modifying eligible homeowners' loans. But more people have been bounced from the program than have been helped by it.

People who apply for modifications via HAMP sometimes "end up unnecessarily depleting their dwindling savings in an ultimately futile effort to obtain the sustainable relief promised by the program guidelines," the report notes, putting the imprimatur of the federal government on a claim long made by housing experts and homeowner advocates. "Others, who may have somehow found ways to continue to make their mortgage payments, have been drawn into failed trial modifications that have left them with more principal outstanding on their loans, less home equity (or a position further 'underwater'), and worse credit scores.

"Perhaps worst of all," it continues, "even in circumstances where they never missed a payment, they may face back payments, penalties, and even late fees that suddenly become due on their 'modified' mortgages and that they are unable to pay, thus resulting in the very loss of their homes that HAMP is meant to prevent."

That's what Bea Garwood of Pinckney, Mich. and Troy Taliancich of New Orleans, La. say is happening to them after extended HAMP runarounds at the hands of JPMorgan Chase and Bank of America, the nation's second-largest and largest banks by assets, respectively. "They told us we were a great candidate, so we went for it," Garwood told HuffPost in August. "And as a result we're losing our home."

New data released Monday by SIGTARP and the Treasury Department only add to the portrait of a failed program. Over the last five months, an average of just 23,000 new homeowners have signed up for the program, data show, far below where the program started out. In September, just 25,000 new homeowners decided to take President Obama up on his promise. Also last month, less than 28,000 homeowners transitioned from a temporary trial modification plan into a five-year plan of promised lower monthly payments. That's the lowest figure since November 2009, Treasury data show.

During the first three months of the year, about 55,000 homeowners on average received these so-called permanent modifications. During the next three months, April to June, that average increased, to about 56,000 per month. Over the last three months, which ended in September, that average plummeted to about 33,000 per month, a 41 percent decrease from the year's second quarter, according to data from Treasury. Thus far, 728,686 struggling homeowners have been kicked out of the program; just 640,300 remain.

Through the first nine months of this year, "when HAMP has been at its apex," according to SIGTARP, nearly 2.7 million homes have been subject to foreclosure notices, the report notes, citing data from research firm RealtyTrac. "At that pace, foreclosure notices will have been sent to more than 3.5 million homes by the end of the year, an increase of 26 percent over the 2.8 million homes in 2009 and nearly five times the comparable 2006 number," SIGTARP said.

"It is downright immoral and cruel for this administration to continue this charade of offering false hope and false promises in the form of a program that is nothing more than false-advertising that is prolonging the inevitable," Rep. Darrell Issa (R-Calif.), the ranking member of the House Committee on Oversight and Government Reform, said in a statement. Democrats are largely avoiding campaigning this election season on their help for homeowners. During campaign stops in Los Angeles and Las Vegas, two areas ravaged by the growing foreclosure crisis, Obama didn't mention his plan to help homeowners.

Administration officials defend the program, arguing that the crisis was much larger than even they expected when they took office last year; that homeowners who are tossed from the program don't necessarily enter foreclosure; and that the nation's largest mortgage companies have been dragging their feet, and there's not much the administration can do. More than half of Bank of America's trial modifications, for example, have dragged on for longer than six months. Trial plans are supposed to last just three months. The administration has yet to fine a single servicer for noncompliance, or claw back any of the taxpayer dollars they've received thus far for successfully modifying delinquent borrowers' mortgages.

Through August, the eight largest mortgage servicers, which service the bulk of mortgages both inside and outside HAMP, have kicked 525,000 homeowners out of HAMP. Of those, about a quarter either lost their homes or are in process of losing their homes, and another 21 percent have yet to be dealt with, so they're in limbo. That means that just about half of homeowners who have been tossed from Obama's program were actually put in a position to keep their home.

In recent months, the Treasury Department has dramatically downplayed the original goal of HAMP to modify mortgages for three to four million people. "You have to think about HAMP in the context of who it was supposed to help and why," said Phyllis Caldwell, chief of Treasury's homeownership preservation unit. "It set a framework for evaluating mortgage modifications that moved the industry to a standard modification able to reduce payments and gave more than a million homeowners immediate relief through trial modifications that had the potential to become permanent. So what it set out to do worked."

Treasury officials are adamant that not only is the program helping those homeowners who remain in it, but it also has helped those homeowners who have been bounced. In fact, those homeowners who ultimately fell out of the program benefited from the equivalent of a "free tax cut" while they were in the program because over that period, they were paying less on their mortgage than was otherwise required. And, officials say, this came without cost to the taxpayer.

Nonsense, the TARP overseer said Monday. "While it may be true that many homeowners may benefit from temporarily reduced payments even though the modification ultimately fails, Treasury's claim that 'every single person' who participated in HAMP gets a 'significant benefit' is either hopelessly out of touch with the real harm that has been inflicted on many families or a cynical attempt to define success as failure," the report says.

"Worse," it continues, "Treasury's apparent belief that all failed trial modifications are successes may preclude it from seeking to make the meaningful changes necessary to provide the 'sustainable' mortgage relief for struggling families it first promised. What Treasury deems a universal benefit, many homeowners, members of Congress, and a growing number of commentators describe as 'cruel' and offering little more than 'false hope.'"

SigTarp Neil Barofsky has just released the most scathing critique of all the idiots in the administration, with a particular soft spot for Tim Geithner.

On the failure of TARP to increase lending:

As these quarterly reports to congress have well chronicled and as Treasury itself recently conceded in its acknowledgement that "banks continue to report falling loan balances," TARP has failed to "increase lending" with small businesses in particular unable to secured badly needed credit. Indeed, even now, overall lending continues to contract, despite the hundreds of billions of TARP dollars provided to banks with the express purpose to increase lending.

On TARP's sole success of boosting Wall Street bonuses:

While large bonuses are returning to Wall Street, the nation's poverty rate increased from 13.2% in 2008 to 14.3% in 2009, and for far too many, the recession has ended in name only.

On TARP's failure in general:

Finally, the most specific of TARP's Main Street goals, "preserving homeownership" has so far fallen woefully short, with TARP's portion of the Administration's mortgage modification program yielding only approximately 207,000 ongoing permanent modifications since TARP's inception, a number that stands in stark contrast to the 5.5 million homes receiving foreclosure filings and more than 1.7 million homes that have been lost to foreclosure since January2009.

On the Treasury's scam in minimizing publicized AIG losses, and on Geithner as a Wall Street puppet whose actions are increasingly destroying public faith in the government:

While SIGTARP offers no opinion on the appropriateness or accuracy of the valuation contained in the Retrospective, we believe that the Retrospective fails to meet basic transparency standards by failing to disclose: (1) that the new lower estimate followed a change in the methodology that Treasury previously used to calculate expected losses on its AIG investment; and (2) that Treasury would be required by its auditors to use the older, and presumably less favorable, methodology in the official audited financials statements. To avoid potential confusion, Treasury should have disclosed that it had changed its valuation methodology and should have published a side-by-side comparison of its new numbers with what the projected losses would be under the auditor-approved methodology that Treasury had used previously and will use in the future. This conduct has left the Treasury vulnerable to charges it has manipulated its methodology for calculating losses to present two different numbers depending on its audience: one designed for release in early October as part of a multifaceted publicity campaign touting the positive aspects of TARP and emphasizing the reduction in anticipated losses, and one, audited by the GAO for release in November as part of a larger audited financial statement. Here again, Treasury's unfortunate insensitivity to the values of transparency has led it to engage in conduct that risks further damaging public trust in the Government.

On the perpetuation of moral hazard courtesy of TARP:

Increased moral hazard and concentration in the financial industry continue to be a TARP legacy. The biggest banks are bigger than ever, fueled by the Government support and taxpayer-assisted mergers and acquisitions. And the repeated statement that the Government would stand by these banks during the financial crisis has given a significant advantage to the larger "too big to fail" banks, as reflected in their enhanced credit ratings borner from a market perception the Government will still not let these institutions fails, although the impact of this cost may be blunted by recently enacted regulatory reform.

On the "cruel, false hope" provided by a "cynical" (if not much harsher word) Treasury Secretary:

While it may be true that many homeowners may benefit from temporarily reduced payments even though the modification ultimately fails, Treasury's claim that "every single person" who participated in HAMP gets a "significant benefit" is either hopelessly out of touch with the real harm that has been inflicted on many families or a cynical attempt to define success as failure. Worse, Treasury's apparent belief that all failed trial modifications are successes may preclude it from seeking to make the meaningful changes necessary to provide the "sustainable" mortgage relief for struggling families it first promised. What Treasury deems a universal benefit, many homeowners, members of Congress, and a growing number of commentators describe as "cruel" and offering little more than "false hope."

On the Treasury's only real focus: bailing out Wall Street and letting Main Street to rot. Granted Hank Paulson is to be blamed here as well for being, what else, a former Goldman CEO, only intent on bailing out his cronies and receiving favorable quotes in books published by journalists known only for their legendary namedropping skills. In this case, it is also one Steve Rattner whose disastrous handling of the GM fiasco is finally coming back to haunt him:

At a time when the country was experiencing the worst economic downturn in generations and the Government was asking its taxpayers to support a $787 billion stimulus package designed primarily to preserve jobs, Treasury made a series of decisions that may have substantially contributed to the accelerated shuttering of more than 2,000 small businesses, thereby potentially adding tens of thousands of workers to the already lengthy unemployment rolls -all without sufficient consideration of the decisions' broader economic impact...That the automakers have offered reinstatement to hundreds of terminated dealerships in response to Congressional action without any apparent sacrifice of their ongoing viability further demonstrates the possibility that such dramatic and accelerated dealership closings may not have been necessary and underscores the need for Treasury to tread very carefully when considering such decisions in the future.

That's ok. There were record Wall Street bonuses to be paid in 2008, 2009, and, now, in 2010. Thank you TARP.

If after all this disclosure Geithner does not resign, well, America truly will have the Treasury Secretary, not to mention administration, it deserves. And while Timmy is packing his office, can Chris Dodd and Barney Frank please exit by the back door (no pun intended) as well, so this country can finally rid itself of the corrupt oligarchy that does everything to benefit banking and nothing to boost actual economic growth.

There is much more in the 388 page report, which we are combing through right now

Most recent data shows a two-month 5.9% price decline representing a magnitude and speed of decline not seen since March 2009; similar declines for September and October expected to appear in other industry indices in coming months.

Clear Capital (www.clearcapital.com), is issuing this special alert on a dramatic change observed in U.S. home prices. “Clear Capital’s latest data shows even more pronounced price declines than our most recent HDI market report released two weeks ago,” said Dr. Alex Villacorta, senior statistician, Clear Capital. “At the national level, home prices are clearly experiencing a dramatic drop from the tax credit-induced highs, effectively wiping out all of the gains obtained during the flurry of activity just preceding the tax credit expiration.”

This special Clear Capital Home Data Index (HDI) alert shows that national home prices have declined 5.9% in just two months and are now at the same level as in mid April 2010, two weeks prior to the expiration of the recent federal homebuyer tax credit. This significant drop in prices, in advance of the typical winter housing market slowdowns, paints an ominous picture that will likely show up in other home data indices in the coming months.

For example, both Clear Capital and S&P/Case-Shiller indices have displayed consistent market peak, trough, secondary trough, and tax credit run-ups. Despite these consistencies, a critical difference is that HDI’s patent pending methodology enables more timely and granular reporting. Therefore, if previous correlations between the Clear Capital and S&P/Case-Shiller indices continue as expected, the next two months will show a similar downward trend in S&P/Case Shiller numbers.

OK, so by now you have heard that existing home sales were up 10% in August. At least that’s what the NAR and the mainstream media reported. Yes, there were some qualifications added to those media reports. But there's more to it. Here are a few facts, or as Paul Harvey would say, "The rest of the story".

Sales were down 8.5% month to month. The seasonal hocus pocus is particularly misleading this month because sales were already extremely depressed for this time of year. The fact is that the market is getting worse. Volume was 379k in September, down from 414k in August. This compares with 498k in August 2009, and 468k in September 2009. Sales are down 19% y/y. This is the worst September in at least the last 10 years.

Median prices were down a whopping 4% m/m and are now down 6.5% since June. This reflects the removal of the artificial price distortion caused by the homebuyers’ tax credit. This is a return to a real market based price, rather than one artificially and falsely inflated. Or at least it’s market based to the extent that it is also skewed by the Fed’s mortgage rate subsidy via its purchases of Treasuries.

In addition to the other seasonal hocus pocus, the NAR also adjusted August inventory up from 3,982,000 to 4,117,000. That enabled them to report an inventory decline to 4,040,000. Inventory is up 330k units, or 8.9% y/y. The inventory to sales ratio stands at 10.66 vs. 7.93 last September. Any way you look at the real numbers, they are catastrophic. The idea that there’s any improvement at all here is just completely false.

So given that things are already catastrophic, what happens when the Fed finally stops subsidizing mortgage rates? Of course the operative word is "when." Who knows? My guess is when the commodity futures vigilantes force the Fed’s hand via raging commodity price appreciation (inflation) that gobsmacks consumers into ratcheting down discretionary spending again. I imagine that will come within 6 months. The amazing thing is that the huge drop in mortgage rates over the past 6 months has not boosted sales one iota. The Fed has wasted our money trying to achieve something that just can’t be achieved. What else is new?

Fact is, you can not stabilize an oversupplied market by artificially propping demand. Such moves are always temporary, and always leave behind a demand vacuum. They have to remove supply from the market permanently to cope with the now embedded high levels of unemployment. The fact remains that the total number of employed remains in a downtrend. That means household formation remains negative, even though the census bureau has yet to make it official. It will when the 2010 data is finalized. Most economists are still assuming that the number of households is still growing in the US. That’s just another one of their lies.

These Wall Street chief economists are all pathological liars. They lie so much, they actually believe their own BS. Their job is to move inventory, not to provide honest forecasts freely to the public via the mainstream media. To them the media like WSJ and CNBS are just infomercial channels Never forget, Wall Street is just a wholesale to retail distribution machine. Lying is just a time honored sales tactic.

In recent months, worshippers at the altar of Keynes have been hyperventilating over the possibility Congress will run a deficit of "only" $1.5 trillion in 2010. They have issued dire proclamations about a replay of the 1937-1938 Depression within the Great Depression. White House favorite and #1 Keynesian on the planet, Paul Krugman, declared that not borrowing an additional $100 billion to hand out to the unemployed for another 99 weeks would surely plunge the country into recession again:

"Suddenly, creating jobs is out, inflicting pain is in. Condemning deficits and refusing to help a still-struggling economy has become the new fashion everywhere, including the United States, where 52 senators voted against extending aid to the unemployed despite the highest rate of long-term joblessness since the 1930s. Many economists, myself included, regard this turn to austerity as a huge mistake. It raises memories of 1937, when F.D.R.’s premature attempt to balance the budget helped plunge a recovering economy back into severe recession." - Paul Krugman in NYT

So did Roosevelt’s attempt to balance the budget in 1937 cause the second major downturn in 1938? I’m a trusting soul, but I prefer to verify what is being peddled to me by any economist, especially Paul Krugman.

Ghost of Keynes PastToday’s Keynesian economists have convinced boobus Americanus that the Great Depression was caused by the Federal Reserve being too tight with monetary policy and the Hoover administration not providing enough fiscal stimulus. Ben Bernanke and Barack Obama used this line of reasoning to ram through an $850 billion pork-laden stimulus package, as well as the purchase of $1.2 trillion of toxic mortgages by the Federal Reserve.

The only trouble is that this storyline is a complete sham.

The fact that colossal stimulus spending, zero interest rates, the purchase of over a trillion in toxic assets by the Fed, and the loosest monetary policy in history have done absolutely nothing to revitalize the economy, has proven that Keynesian policies have been a wretched failure. This is not a surprise to Austrian school economists.

Keynesian policies failed during the Great Depression, and they are failing today. An economic catastrophe caused by loose monetary policies, crushing levels of debt, and appalling lending practices cannot be solved by looser monetary policies, issuance of twice as much debt, and government commanding banks (or, in the case of Fannie and Freddie, "commandeering") to make more bad loans.

Ludwig von Mises described what happened in the 1920s and 1930s. His explanation accurately illustrates the situation in America today.

"There is no means of avoiding the final collapse of a boom brought on by credit and fiat monetary expansion. The only question is whether the crisis should come sooner in the form of a recession or later as a final and total catastrophe of depression as the currency systems crumble."

The Roaring TwentiesThey don’t call the 1920s roaring because money wasn’t flowing freely and consumers were practicing frugality. The newly created Federal Reserve expanded credit by setting below-market interest rates and low reserve requirements that favored the big Wall Street banks. The Federal Reserve increased the money supply by 60% during the period following the recession of 1921. By the latter part of the decade, "buying on margin" entered the American vocabulary as more and more Americans overextended themselves to speculate on the soaring stock market.

The 1920s marked the beginning of mass production and the emergence of consumerism in America, with automobiles a prominent symbol of the latter. In 1919, there were just 6.7 million cars on American roads. By 1929, the number had grown to more than 27 million cars, or nearly one car for every household. During this period banks offered the country's first home mortgages and manufacturers of everything – from cars to irons – allowed consumers to pay "on time." Installment credit soared during the 1920s. About 60% of all furniture and 75% of all radios were purchased on installment plans. Thrift and saving were replaced in the new consumer society by spending and borrowing.

Encouraging the spending, the three Republican administrations of the 1920s practiced laissez-faire economics, starting by cutting top tax rates from 77% to 25% by 1925. Non-intervention into business and banking became government policy. These policies led to overconfidence on the part of investors and a classic credit-induced speculative boom. Gambling in the markets by the wealthy increased. While the rich got richer, millions of Americans lived below the household poverty line of $2,000 per year. The days of wine and roses came to an abrupt end in October 1929, with the Great Stock Market Crash.

Between 1929 and 1932, the market fell 89% from its high. The Keynesian storyline is that Herbert Hoover’s administration did nothing to try and revive the economy. It took Franklin Delano Roosevelt and his New Deal Keynesian policies to save the country. It’s a nice story, but completely false. Between 1929 and 1933, when Roosevelt came to power, the Hoover administration increased real per-capita federal expenditures by 88%, not exactly austere.

Excessive Consumer Spending When examining the BEA chart of GDP from 1929 to 1939, some fascinating similarities with today’s economy leap out. In 1929, consumer expenditures accounted for 72.3% of GDP, confirming that the much-commented-upon American consumerism is not a modern development. In fact, consumer spending peaked at 81% of GDP in 1932 and remained above 70% during the entire depression.

By 1950 consumer expenditures had subsided to 64% of GDP. In 1960, they had fallen to 63% and edged up to 64% by 1970, where they remained until 1980. By 1990 they had ticked up to 66% and by 2000 had reached 68%. The modern-day climax appeared to many to have been reached in 2007 at 70% of GDP. But in a replay of the New Deal playbook, where much of the consumerism was funded by make-work projects and federal transfer payments, the federal government has thrown billions of dollars at consumers to buy houses, cars, and appliances. Consumer expenditures as a percentage of GDP actually rose to 71% in 2009. It should be readily apparent that until consumer expenditures are narrowed to a level that leads to a sustainable balanced economy, the current depression will continue indefinitely.

Bureau of Economic Analysis National Income and Product Accounts Table

The Depression Within the DepressionThe Great Depression lasted from 1929 until 1940. What is not well known is that GDP was at the same level in 1936 as it had been in 1929. In no small part because GDP soared by 37% between 1933 and 1936. The unemployment rate in 1929 was 5%. In 1936, even after GDP had recovered to pre-depression levels, the unemployment rate was still 15%. It spiked back to 18% in 1938 and stayed above 15% until World War II. Tellingly, in 1936, private domestic investment was 21% below the level of 1929.

By contrast, government expenditures surged by 46% between 1929 and 1936. With the government creating agencies and hiring people into make-work projects, private industry was crowded out. The extensive governmental economic planning and intervention that began during the Hoover administration was expanded significantly under Roosevelt. The bolstering of wage rates and prices, expansion of credit, propping up of weak firms, and increased government spending on public works prolonged the Great Depression.

The evidence strongly contradicts the notion promoted by Krugman and other Keynesian worshippers that the supposed 1937-38 Depression within the Great Depression was caused by Roosevelt becoming a believer in austerity. In fact, GDP only dropped by 3.5% in 1938 and rebounded by 8.1% in 1939. What actually collapsed in 1938 was private investment, which fell 34%. By contrast, government spending declined by only 4.5% in 1938, confirming that Roosevelt did not slash spending. To the extent that he eased up on the accelerator, it was by cutting back on jobs programs like those provided by the Works Progress Administration and the Public Works Administration.

The reason private investment collapsed in 1938 was Roosevelt’s anti-business crusade. He denounced big business as the cause of the depression. In March 1938, FDR appointed Yale University law professor Thurman Arnold to head the antitrust division of the Justice Department. Arnold soon hired some 300 lawyers to file antitrust lawsuits against businesses. Arnold launched cases against entire industries, with lawsuits against the milk, oil, tobacco, shoe machinery, tires, fertilizer, railroad, pharmaceuticals, school supplies, billboards, fire insurance, liquor, typewriter, and movie industries.

The Greater Depression and Excessive Debt

Some ConclusionsThe mainstream media’s popular narrative about the causes and cure for the Great Depression invariably start with the storyline that the stock market crash caused the Great Depression. Herbert Hoover purportedly refused to spend government money in an effort to reinvigorate the economy. Franklin Delano Roosevelt’s New Deal government spending programs allegedly saved America.

This storyline is a big lie.

The Great Depression was caused by Federal Reserve expansion of the money supply in the 1920s that led to an unsustainable credit-driven boom. When the Federal Reserve belatedly tightened in 1928, it was too late to avoid financial collapse. According to Murray Rothbard, in his book America’s Great Depression, the artificial interference in the economy was a disaster prior to the depression, and government efforts to prop up the economy after the crash of 1929 only made things worse. Government intervention delayed the market’s adjustment and made the road to complete recovery more difficult.

The parallels with today are uncanny. Alan Greenspan expanded the money supply after the dot-com bust, dropped interest rates to 1%, encouraged a credit-driven boom, and created a gigantic housing bubble. By the time the Fed realized they had created a bubble, it was too late. The government response to the 2008 financial collapse has been to expand the money supply, reduce interest rates to 0%, borrow and spend $850 billion on useless make-work pork projects, encourage spending by consumers on cars and appliances, and artificially prop up housing through tax credits and anti-foreclosure programs. The National Debt has been driven higher by $2.7 trillion in the last 18 months.

The government has sustained insolvent Wall Street banks with $700 billion of taxpayer funds and continues to waste taxpayer money on dreadfully run companies like Fannie Mae, Freddie Mac, General Motors, and Chrysler. The government is prolonging the agony by not allowing the real economy to bottom and begin a sound recovery based on savings, investment, and sustainable fiscal policies. President Obama continues to scorn business by creating more burdensome healthcare, financial, and energy regulations.

Today’s politicians and monetary authorities have learned the wrong lessons from the Great Depression. The result will be a second, Greater Depression and more pain for the middle class. The investment implications of government stimulus programs are further debasement of the currency and ultimately inflation and surging interest rates. Owning precious metals and mining stocks, and shorting U.S. Treasuries will pay off over the next few years.

With just over a week left to the QE2 announcement, discussion over the amount, implications and effectiveness of QE2 are almost as prevalent (and moot) as those over the imminent collapse of the MBS system. Although whereas the latter is exclusively the provenance of legal interpretation of various contractual terms, and as such most who opine either way will soon be proven wrong to quite wrong, as in America contracts no longer are enforced (did nobody learn anything from the GM/Chrysler fiasco for pete's sake), when it comes to printing money the ultimate outcome will certainly have an impact. And the more the printing, the better.

One of the amusing debates on the topic has been how much debt will the Fed print. Those who continue to refuse to acknowledge that the economy is in a near-comatose state, of course, hold on to the hope that the amount will be negligible: something like $500 billion (there was a time when half a trillion was a lot of money). A month ago we stated that the full amount will be much larger, and that the Fed will be a marginal buyer of up to $3 trillion. Turns out, even we were optimistic. A brand new analysis by Jan Hatzius, which performs a top down look at how much monetary stimulus is needed to fill the estimated 300 bps hole between the -7% Taylor Implied Funds Rate (of which, Hatzius believes, various other Federal interventions have already filled roughly 400 bps of differential) and the existing 0.2% FF rate.

Using some back of the envelope math, the Goldman strategist concludes that every $1 trillion in new LSAP (large scale asset purchases) is the equivalent of a 75 bps rate cut (much less than comparable estimates by Dudley, 100-150bps, and Rudebusch, 130bps). In other words: the Fed will need to print $4 trillion in new money to close the Taylor gap. And here we were thinking the economy is in shambles. Incidentally, $4 trillion in crisp new dollar bills (stored in bank excess reserve vaults) will create just a tad of buying interest in commodities such as gold and oil...

Here is the math.

First, Goldman calculates that the gap to close to a Taylor implied funds rate is 7%.

"Our starting point is Chairman Bernankes speech on October 15, which defined the dual mandate as an inflation rate of two percent or a bit below and unemployment equal to the committees estimate of the long-term sustainable rate. The Fed's job is then to provide just enough stimulus or restraint to put the forecast for inflation and unemployment on a glide path to the dual mandate over some reasonable period of time. Indeed, Fed officials have implicitly pursued just such a policy since at least the late 1980s.

To quantify the Feds approach, we have estimated a forward-looking Taylor-style rule that relates the target federal funds rate to the FOMCs forecasts for core PCE inflation and the unemployment gap (difference between actual and structural unemployment). At present, this rule points to a desired federal funds rate of -6.8%, as shown in Exhibit 1.3 Since the actual federal funds rate is +0.2%, our rule implies on its face that the existence of the zero lower bound on nominal interest rates has kept the federal funds rate 700 basis points (bp) too high.

It is important to be clear about the meaning of this policy gap. It does not meanas is sometimes allegedthat policy is tight in an absolute sense, much less that it will necessarily push the economy back into recession. In fact, policy as measured by the real federal funds rate of -1% is very easy. However, our policy rule implies that under current circumstanceswith the Fed missing to the downside on both the inflation and employment part of the dual mandate (and by a large margin in the latter case) a very easy policy is not good enough. Instead, policy should be massively easy to facilitate growth and job creation, fill in the output gap, and ultimately raise inflation to a mandate-consistent level.

The 700bp policy gap clearly overstates the extent of the policy miss because it ignores (1) the expansionary stance of fiscal policy, (2) the LSAPs that have already occurred and (3) the FOMCs extended period commitment to a low funds rate. We attempt to incorporate the implications of these for the policy gap in two steps.

First, we obtain an estimate of how much the existing unconventional Fed policies have eased financial conditions. In previous work we showed that the first round of easing pushed down short- and long-term interest rates, boosted equity prices and led to depreciation of the dollar. Although our estimates are subject to a considerable margin of error, they suggest that QE1 has boosted financial conditionsas measured by our GSFCI by around 80bp per $1 trillion (trn) of purchases. Moreover, our estimates suggest that the extended period language has provided an additional 30bp boost to financial conditions. A number of studies undertaken at the Fed similarly point to sizable effects on financial conditions. A New York Fed study, for example, finds that QE1 has pushed down long-term yields by 38-82bp. A paper by the St. Louis Fed also finds a sizable boost to financial conditions more generally, including equity prices and the exchange rate.

Second, we translate this boost to financial conditionsas well as the expansionary fiscal stanceinto funds rate units. To do so, we attempt to quantify the relative impact of changes in the federal funds rate, fiscal policy and the GSFCI on real GDP. As such estimates are subject to considerable uncertainty we take the average effect across a number of existing studies (see Exhibit 2). With regard to monetary policy, the studies we consider suggest that a 100bp easing in the funds rate, on average, boosts the level of real GDP by 1.6% after two years. A fiscal expansion worth 1% of GDP, on average, raises the level of GDP by 1.1% two years later. Using existing studies to gauge the effects of an easing in our GSFCI on output is more difficult as other researchers construct their financial conditions indices in different ways. Taking the average across studies that report effects for the components of their indicesthus allowing us to re-weight the effects for our GSFCI and our own estimate suggests that a 100bp easing in financial conditions increases the level of GDP by around 1.5% after two years.

What does this mean for the real impact on the implied fund rate from every incremental dollar of purchases?

Combining these two steps suggests that $1trn of asset purchases is equivalent to a 75bp cut in the funds rate (calculated as the effect of LSAPs on financial conditions (80bp), multiplied by the effect of financial conditions on GDP (1.5%), divided by the effect of the funds rate on GDP (1.6%)). This estimate reinforces the view that QE1 helped to substitute for conventional policy. Our estimate, however, is less optimistic than the 100-150bp range cited by New York Fed President Dudley, or the 130bp implied by Glenn Rudebusch of the San Francisco Fed.

In terms of the other policy levers, our analysis implies that the extended period language is worth around 30bp cut in the funds rate and a fiscal stimulus of 1% of GDP is equivalent to around 70bp of fed funds rate easing.

So how much more work should the FOMC do Exhibit 3 shows that consideration of policy levers other than the funds rate cuts the estimated policy gap by more than half, from 700bp to 300bp. Of this 400bp reduction, the easy stance of fiscal policy is worth 240bp; QE1 is worth 130bp; and the existing commitment language is worth another 30bp.

And the kicker, which shows just how naive we were:

We can then express the remaining policy gap in terms of the required additional LSAPs. Using our estimate that $1trn in LSAPs is worth an estimated 75bp cut in the federal funds rate and assuming that all other policy levers stay where they are at present, Fed officials would need to buy an additional $4trn to close the remaining policy gap of 300bp.

Now, for the amusing part: what does $4 trillion in purchases means for inflation. Or, a better question, when will $4 trillion be priced in...

In reality, the FOMC is unlikely to authorize additional LSAPs of as much as $4trn, unless the economy performs much worse than we are forecasting. The committee perceives LSAPs as considerably more costly than an equivalent amount of conventional monetary stimulus, and is therefore not likely to use the two interchangeably. Many Fed officials believe that there are significant tail risks associated with LSAPs and the associated increase in the Feds aggregate balance sheet. These risks include the possibility of substantial mark-to-market losses on the Feds investment, which might prove embarrassing in the Feds dealings with Congress and could, in theory, undermine its independence. They also include the possibility that the associated sharp increase in the monetary base will lead households and firms to expect much higher inflation at some point in the future.

Unfortunately, it is extremely difficult to put a number on the perceived or actual cost of an extra $1trn in LSAPs in terms of these tail risks. However, we have some information on how the FOMC has behaved to date that might reveal Fed officials perception of these costs.

Oddly, nobody ever talks about the impact of "unconvential" printing of trillions on commodities such as oil and gold. They will soon.

Our analysis is therefore consistent with additional asset purchases of around $2trn if the FOMCs forecasts converge to our own. It is unlikely, however, that the FOMC will announce asset purchases of this size in the very near term. Rather, our analysis suggests that the timing of the announcements should depend on whether, and how quickly, the FOMCs forecasts converge to ours.

Hatzius pretty much says it all- suddenly the market will be "forced" to price in up to 4 times as much in additional monetary loosening from the "convention wisdom accepted" $1 trillion. We have just one thing to add. If Goldman has underestimated the impact of existing fiscal and monetary intervention, and instead of closing 4% of the Taylor gap, the actual impact has been far less negligible (and if Ferguson is right in assuming that all this excess money has in fact gone to chasing emerging market and commodity bubbles), it means that, assuming 75bps of impact per trillion, the Fed will not stop until it prints nearly ten trillion in incremental money beginning on November 3. That's almost more than M1 and M2 combined.

The reasons for his failure to reap credit for any economic accomplishments are a catechism by now: the dark cloud cast by undiminished unemployment, the relentless disinformation campaign of his political opponents, and the White House’s surprising ineptitude at selling its own achievements. But the most relentless drag on a chief executive who promised change we can believe in is even more ominous. It’s the country’s fatalistic sense that the stacked economic order that gave us the Great Recession remains not just in place but more entrenched and powerful than ever.

No matter how much Obama talks about his “tough” new financial regulatory reforms or offers rote condemnations of Wall Street greed, few believe there’s been real change. That’s not just because so many have lost their jobs, their savings and their homes. It’s also because so many know that the loftiest perpetrators of this national devastation got get-out-of-jail-free cards, that too-big-to-fail banks have grown bigger and that the rich are still the only Americans getting richer.

This intractable status quo is being rubbed in our faces daily during the pre-election sprint by revelations of the latest banking industry outrage, its disregard for the rule of law as it cut every corner to process an avalanche of foreclosures. Clearly, these financial institutions have learned nothing in the few years since their contempt for fiscal and legal niceties led them to peddle these predatory mortgages (and the reckless financial “products” concocted from them) in the first place. And why should they have learned anything? They’ve often been rewarded, not punished, for bad behavior.

The latest example is Angelo Mozilo, the former chief executive of Countrywide and the godfather of subprime mortgages. On the eve of his trial 10 days ago, he settled Securities and Exchange Commission charges for $67.5 million, $20 million of which will be footed by what remains of Countrywide in its present iteration at Bank of America. Even if he paid the whole sum himself, it would still be a small fraction of the $521 million he collected in compensation as he pursued his gambling spree from 2000 until 2008.

A particularly egregious chunk of that take was the $140 million he pocketed by dumping Countrywide shares in 2006-7. It was a chapter right out of Kenneth Lay’s Enron playbook: Mozilo reassured shareholders that all was peachy even as his private e-mail was awash in panic over the “toxic” mortgages bringing Countrywide (and the country) to ruin. Lay, at least, was convicted by a jury and destined to decades in the slammer before his death.

It should pain the White House that its departing economic guru, the Rubin protégé Lawrence Summers, is an even bigger heavy in “Inside Job” than in the hit movie of election season, “The Social Network.” Summers — like the former Goldman Sachs chief executive and Bush Treasury secretary Hank Paulson — is portrayed as just the latest in a procession of policy makers who keep rotating in and out of government and the financial industry, almost always to that industry’s advantage. As the star economist Nouriel Roubini tells the filmmaker, Charles Ferguson, the financial sector on Wall Street has “step by step captured the political system” on “the Democratic and the Republican side” alike. But it would be wrong to single out Summers or any individual official for the Obama administration’s image of being lax in pursuing finance’s bad actors. This tone is set at the top.

Asked in “Inside Job” why there’s been no systematic investigation of the 2008 crash, Roubini answers: “Because then you’d find the culprits.” With the aid of the “Manhattan Madam” (and current stunt New York gubernatorial candidate) Kristin Davis, the film also asks why federal prosecutors who were “perfectly happy to use Eliot Spitzer’s personal vices to force him to resign in 2008” have not used rampant sex-and-drug trade on Wall Street as a tool for flipping witnesses to pursue the culprits behind the financial crimes that devastated the nation.

The Obama administration seems not to have a prosecutorial gene. It’s shy about calling a fraud a fraud when it occurs in high finance. This caution was exemplified most recently by the secretary of housing and urban development, Shaun Donovan, whose response to the public outcry over the banks’ foreclosure shenanigans was to take to The Huffington Post last weekend. “The notion that many of the very same institutions that helped cause this housing crisis may well be making it worse is not only frustrating — it’s shameful,” he wrote.

Well, yes! Obama couldn’t have said it more eloquently himself. But with all due respect to Secretary Donovan’s blogging finesse, he wasn’t promising action. He was just stroking the liberal base while the administration once again punted. In our new banking scandal, as in those before it, attorneys general in the states, where many pension funds were decimated by Wall Street Ponzi schemes, are pursuing the crimes Washington has not. The largest bill of reparations paid out by Bank of America for Countrywide’s deceptive mortgage practices — $8.4 billion — was to settle a suit by 11 state attorneys general on the warpath.

Since Obama has neither aggressively pursued the crash’s con men nor compellingly explained how they gamed the system, he sometimes looks as if he’s fronting for the industry even if he’s not. Voters are not only failing to give the White House credit for its economic successes but finding it guilty of transgressions it didn’t commit. The opposition is more than happy to pump up that confusion. When Mitch McConnell appeared on ABC’s “This Week” last month, he typically railed against the “extreme” government of “the last year and a half,” citing its takeover of banks as his first example. That this was utter fiction — the takeover took place two years ago, before Obama was president, with McConnell voting for it — went unchallenged by his questioner, Christiane Amanpour, and probably by many viewers inured to this big lie.

The real tragedy here, though, is not whatever happens in midterm elections. It’s the long-term prognosis for America. The obscene income inequality bequeathed by the three-decade rise of the financial industry has societal consequences graver than even the fundamental economic unfairness. When we reward financial engineers infinitely more than actual engineers, we “lure our most talented graduates to the largely unproductive chase” for Wall Street riches, as the economist Robert H. Frank wrote in The Times last weekend. Worse, Frank added, the continued squeeze on the middle class leads to a wholesale decline in the quality of American life — from more bankruptcy filings and divorces to a collapse in public services, whether road repair or education, that taxpayers will no longer support.

Even as the G.O.P. benefits from unlimited corporate campaign money, it’s pulling off the remarkable feat of persuading a large swath of anxious voters that it will lead a populist charge against the rulers of our economic pyramid — the banks, energy companies, insurance giants and other special interests underwriting its own candidates. Should those forces prevail, an America that still hasn’t remotely recovered from the worst hard times in 70 years will end up handing over even more power to those who greased the skids.

We can blame much of this turn of events on the deep pockets of oil billionaires like the Koch brothers and on the Supreme Court’s Citizens United decision, which freed corporations to try to buy any election they choose. But the Obama White House is hardly innocent. Its failure to hold the bust’s malefactors accountable has helped turn what should have been a clear-cut choice on Nov. 2 into a blurry contest between the party of big corporations and the party of business as usual.

The Federal Reserve’s push toward easier monetary policy is the "wrong way" to stimulate growth and may amount to a manipulation of the dollar, German Economy Minister Rainer Bruederle said. Fed Chairman Ben S. Bernanke yesterday gave Group of 20 finance ministers and central bankers meeting in Gyeongju, South Korea an overview of the U.S. central bank’s efforts to jumpstart the world’s largest economy. His strategy, which investors expect will soon include greater asset purchases, drew criticism at the talks, said Bruederle.

"It’s the wrong way to try to prevent or solve problems by adding more liquidity," Bruederle told reporters yesterday, saying that emerging-market officials were among the critics. Bruederle, a member of the Free Democratic Party, the junior partner in Chancellor Angela Merkel’s government, stepped in for hospitalized Finance Minister Wolfgang Schaeuble at the meeting.

The debate over the Fed’s strategy comes as the G-20’s advanced nations sought to alleviate concerns over big swings in capital flows to emerging markets by promising to be "vigilant against excess volatility" in exchange rates. The U.S. central bank completed purchases of about $1.7 trillion of debt in March to support the recovery. The policy-setting Federal Open Market Committee next meets Nov. 2-3.

Bill Gross, Pacific Investment Management Co.’s co-founder and manager of the world’s biggest mutual fund, said Oct. 8 on Bloomberg TV the central bank may buy about $100 billion in government debt a month, or $1.2 trillion over the next year.

"Indirect Manipulation""Excessive, permanent money creation in my opinion is an indirect manipulation of an exchange rate," Bruederle said. The minister has taken a pro-market stance in his first year in office, criticizing state intervention in cases such as providing aid for General Motors Co.’s German Opel unit. U.S. Treasury Secretary Timothy F. Geithner dismissed prospects of mounting criticism of the Fed’s approach in his press conference after the G-20 meeting yesterday. When asked whether he expected Germany’s criticisms to gain steam, he replied: "I do not."

The Treasury chief declined to comment directly on the Fed’s policy, while also saying that major economies like the U.S. need to make growth a top priority. One of the global imbalances is the disparity between rapidly expanding emerging- market economies and too-slow growth in developed nations, he said. "We are going to continue to try to strengthen the recovery under way so we can dig out of this as quickly as we can," Geithner said.

European Central Bank President Jean-Claude Trichet said that the G-20 made "no particular conclusion" after some members expressed concern about proposals for further quantitative easing in the U.S. "The remark was made that the accommodating policy vis-a- vis the U.S. might mean problems for the emerging economies, at least in terms of inflation," he said. "The point was made that it was much more complicated than that" and that combating deflation "was also a contribution to global prosperity. It was an exchange of views, with no particular conclusion."

Bernanke said in an Oct. 15 speech that "the risk of deflation was higher than desirable" and that U.S. inflation rates are too low. He said the central bank could expand asset purchases or change the language in its statement, without offering details on how the Fed would undertake those strategies at its November meeting. The central bank already decided in August to keep its balance sheet from shrinking.

Asset BubblesLow interest rates and weak recoveries in industrialized economies such as the U.S. have forced investors to flood emerging markets with capital, providing resources for growth yet also threatening to spur inflation, asset bubbles and over- valued exchange rates. Such concerns have prompted economies from South Korea to Brazil to take steps to slow the inflow of speculative cash. "I’m not a friend of this but I can understand" why Brazil introduced capital controls, Bruederle said.

Emerging-market equity mutual funds attracted more than $60 billion this year and bond funds lured $41 billion, both on pace for record annual inflows, according to data compiled by EPFR Global, a Cambridge, Massachusetts-based research firm. Forty- nine percent of money managers are now overweight developing- markets equities, the highest level since 2009, according to a BofA Merrill Lynch survey released this month.

Sacrosanct tax breaks, including deductions on mortgage interest, remain on the table just weeks before the deficit commission issues recommendations on policies to pare back with the aim of balancing the budget by 2015. The tax benefits are hugely popular with the public but they have drawn the panel's focus, in part because the White House has said these and other breaks cost the government about $1 trillion a year.

At stake, in addition to the mortgage-interest deductions, are child tax credits and the ability of employees to pay their portion of their health-insurance tab with pretax dollars. Commission officials are expected to look at preserving these breaks but at a lower level, according to people familiar with the matter. The officials are also looking at potential cuts to defense spending and a freeze on domestic discretionary spending. It is unclear if the 18-member panel will be able to reach an agreement on any of the items by a Dec. 1 deadline.

Even if they do reach an agreement, any curbs on current tax breaks would likely face tough sledding in Congress. The banking and real-estate lobbies have fiercely rebuffed efforts to rescind the mortgage-interest deduction in the past. Still, officials have found there aren't any easy ways to balance the budget, and they are expected to steer clear of more polarizing issues like Medicare, Medicaid, Social Security and a broad rewrite of the tax code in their short-term recommendations. The panel could still make long-term recommendations to change these issues, but they would be less concrete.

"My concern is that the talk of tax expenditures is couched as 'tax reform,' but it's not tax reform," said Alison Fraser, director of the Thomas A. Roe Institute for Economic Policy Studies at the conservative Heritage Foundation. "It's simply a revenue-raising exercise." Committee officials plan to try to broker a deal in November, after the midterm elections. They have until Dec. 1 to win the support of 14 of the commission's 18 members to endorse a final report. It is possible that the panel's Democrats and Republicans would issue separate reports if they can't agree, people familiar with the process said.

President Barack Obama created the National Commission on Fiscal Responsibility and Reform in February, amid concern from lawmakers and economists that the growing budget deficit could damage the country's long-term fiscal condition. The bipartisan panel, made up mostly of lawmakers but also business and labor leaders, has met for months, at times more constructively than many expected. "There's a lot of potential for agreement on the committee," said panel member Alice Rivlin, a senior fellow at the liberal-leaning Brookings Institution.

If the commission reaches a consensus, House or Senate leaders could agree to bring some of the changes up for a vote, perhaps early next year, although there is no deadline. To balance the budget by 2015, excluding interest payments on debt, means officials would need to find roughly $240 billion in annual savings, according to commission documents. Panel officials also hope to issue recommendations that would "meaningfully improve" the country's long-term fiscal situation.

Even though officials are focusing on issues where they believe they can get broad agreement, they will likely face stiff resistance from certain lawmakers and interest groups. Some Republicans are expected to label any caps on tax breaks as a backdoor way of raising taxes. Several lawmakers' offices declined to comment on specific proposals as negotiations aren't yet under way.

Committee officials have also focused on the $700 billion in annual defense spending, which accounts for more than half of domestic discretionary spending. Critics say the government could cut some of the $400 billion spent on outside contractors. But many conservative groups have said cutting military spending would be a mistake, citing national security risks. Changes to Medicaid and Medicare are unlikely to be recommended despite their looming presence in the U.S. budget. The Congressional Budget Office has estimated that if laws don't change, federal spending on health care alone will grow from 5% of gross domestic product in 2010 to 10% in 2035.

Commission officials looked closely at making short-term changes to Social Security, but talks shifted in recent weeks toward incorporating those ideas into a longer-term plan. This is in part because any changes would probably have to be phased in over years, delaying the budgetary impact for at least a decade. "My sense from talking to members of the commission is that's where they are focusing [on the long-term recommendation], Social Security reform," said Martin Feldstein, an economics professor at Harvard University who served as a senior official in the Reagan administration.

It remains unclear whether the panel will reach a consensus with negotiations taking place right after the midterm elections, when Washington tends to buzz with political jostling. The imminent debate over whether to extend all or part of the Bush-era tax cuts could also complicate its efforts. The panel isn't expected to weigh in on this issue. The White House said this month that the budget deficit for the last fiscal year was $1.3 trillion, the second highest in 60 years. The government's revenue was roughly $2.16 trillion in the year ended Sept. 30, compared with $3.46 trillion in outlays.

The White House hasn't signed off on any of the potential proposals as it's waiting for the panel to complete its work. Mr. Obama "expects that the fiscal commission will continue the process of discussing and analyzing a wide range of ideas and it is premature to describe any specific idea as a conclusion of a commission that has not even voted yet," White House spokesman Amy Brundage said. The commission "is the last best hope right now for getting some substantive movement on the issue of the deficit, the debt, and the financial disaster we're facing," Sen. Judd Gregg (R., N.H.), a member of the commission, said in a recent interview.

Ministers are planning a massive sell-off of Britain's Government-owned forests as they seek to save billions of pounds to help cut the deficit. Caroline Spelman, the Environment Secretary, is expected to announce plans within days to dispose of about half of the 748,000 hectares of woodland overseen by the Forestry Commission by 2020. The controversial decision will pave the way for a huge expansion in the number of Center Parcs-style holiday villages, golf courses, adventure sites and commercial logging operations throughout Britain as land is sold to private companies.

Legislation which currently governs the treatment of "ancient forests" such as the Forest of Dean and Sherwood Forest is likely to be changed giving private firms the right to cut down trees. Laws governing Britain's forests were included in the Magna Carta of 1215, and some date back even earlier. Conservation groups last night called on ministers to ensure that the public could still enjoy the landscape after the disposal, which will see some woodland areas given to community groups or charitable organisations.

However, large amounts of forests will be sold as the Department for the Environment Food and Rural Affairs (Defra) seeks to make massive budget savings as demanded in last week's Spending Review. Whitehall sources said about a third of the land to be disposed of would be transferred to other ownership before the end of the period covered by the Spending Review, between 2011 and 2015, with the rest expected to go by 2020. A source close to the department said: "We are looking to energise our forests by bringing in fresh ideas and investment, and by putting conservation in the hands of local communities."

Unions vowed to fight the planned sell-off. Defra was one of the worst-hit Whitehall departments under the Spending Review, with Ms Spelman losing around 30 per cent of her current £2.9 billion annual budget by 2015. The Forestry Commission, whose estate was valued in the 1990s at £2.5 billion, was a quango which was initially thought to be facing the axe as ministers drew up a list of arms-length bodies to be culled.

However, when the final list was published earlier this month it was officially earmarked: "Retain and substantially reform – details of reform will be set out by Defra later in the autumn as part of the Government's strategic approach to forestry in England." A spokesman for the National Trust said: "Potentially this is an opportunity. It would depend on which 50 per cent of land they sold off, if it is valuable in terms of nature, conservation and landscape, or of high commercial value in terms of logging. "We will take a fairly pragmatic approach and look at each sale on a case by case basis, making sure the land goes to the appropriate organisations for the right sites, making sure the public can continue to enjoy the land."

Mark Avery, conservation director for the Royal Society for the Protection of Birds (RSPB) said: "You can understand why this Government would think 'why does the state need to be in charge of growing trees', because there are lots of people who make a living from growing trees. "But the Forestry Commission does more than just grow trees. A lot of the work is about looking after nature and landscapes." "We would be quite relaxed about the idea of some sales, but would be unrelaxed if the wrong bits were up for sale like the New Forest, Forest of Dean or Sherwood Forest, which are incredibly valuable for wildlife and shouldn't be sold off.

"We would look very carefully at what was planned. It would be possible to sell 50 per cent if it was done in the right way." A Defra spokesman said: "Details of the Government's strategic approach to forestry will be set out later in the autumn. "We will ensure our forests continue to play a full role in our efforts to combat climate change, protect the environment and enhance biodiversity, provide green space for access and recreation, alongside seeking opportunities to support modernisation and growth in the forestry sector."

Allan MacKenzie, secretary of the Forestry Commission Trade Unions, said: "We will oppose any land sale. Once we've sold it, it never comes back. "Once it is sold restrictions are placed on the land which means the public don't get the same access to the land and facilities that are provided by the public forest estate. "The current system means a vast amount of people can enjoy forests and feel ownership of them. It is an integral part of society."

In 1992 John Major's Conservative government – also looking to save money in a recession – drew up plans to privatise the Forestry Commission's giant estate, which ranges from huge conifer plantations to small neighbourhood woodlands. John Gummer, then the Agriculture Minister, wrote to cabinet colleagues saying that he 'wanted to raise money and get the forest estate out of the private sector'. Mr Major backed the sell- off which, it was hoped, would raise £1 billion. However it was later abandoned following a study by a group of senior civil servants, amid widespread public opposition.

Beautiful job with the professionally produced video of Stoneleigh's "A Century of Challenges". I would like top see a hard copy as well as a DVD in the future. I would imagine most readers of TAE will want to see her fine lecture.

The Kangbashi district began as a public-works project in Ordos, a wealthy coal-mining town in Inner Mongolia. The area is filled with office towers, administrative centers, government buildings, museums, theaters and sports fields—not to mention acre on acre of subdivisions overflowing with middle-class duplexes and bungalows. The only problem: the district was originally designed to house, support and entertain 1 million people, yet hardly anyone lives there.

Real Estate prices have gone up nearly 6 fold in Ordos in the last 6 years. It's basically an empty city of 1.5 Million people.

Kangbashi was projected to have 300,000 residents by now. And the government claims that 28,000 people live in the new area. But during a recent visit, a reporter driving around for hours with two real estate brokers saw only a handful of residents in the housing developments.

Analysts estimate there could be as many as a dozen other Chinese cities just like Ordos, with sprawling ghost town annexes. In the southern city of Kunming, for example, a nearly 40-square-mile area called Chenggong has raised alarms because of similarly deserted roads, high-rises and government offices. And in Tianjin, in the northeast, the city spent lavishly on a huge district festooned with golf courses, hot springs and thousands of villas that are still empty five years after completion.

"What can happen, and does, is that people choose to hold on to what they have, which lowers the velocity of money and temporarily raises -some- prices. This will end when they have to pay up their own debts."

Yes, but what if what is being held is a currency that is being destroyed? When that happens we start playing hot potato with it and that can be a high velocity game, can it not?

The danger the Fed seeks to avoid is deflation's effect on massive Treasury borrowing.

With nominal interest amounting to + $300 billion for this year the increase in principal alone will guarantee interest will consume a larger share of the government's budget. Rates above near zero and extended maturities are fatal to the Treasury along with deflation's effect of payment with more valuable dollars.

The Fed cannot control bond prices because its actions increase risk which is priced into bonds.

The Fed cannot 'help' the banks except by laundering worthless assets they hold into cash.

The QE process is moving funds from one liquidity trap to another which is the intention, BTW. The Fed seeks to mimic Japan's sterilization of its - Japan's - massive deficits.

It was monetarist Milton Friedman who persuaded US fools that a tight money supply caused the Depression. He was half- right. It was gold speculating and the US's 'Austrian' fetish for hard currency that amplified a garden- variety recession into deflation.

Keynes was right about gold but he also missed a point.The Great Depression was both a finance crisis as well as a social and cultural crisis. In the 1930's the developed world was torn between continuing community- level economic activities that had sustained the United States for 150 years - and the rest of the world for centuries - or embrace the 'New' Big Business commercial/industrial model that had emerged at the turn of the 20th century.

Am I the only one who is just sick and tired of hearing the name 'Keynes' bandied about? For Pete's effing sake, the man is dead, he lived in another time, can you who assume yourselves competent to speak to the current times puhleeze stop engaging in the mental masturbation of debating long-dead theorists?

Seriously, it's a new century and theory isn't worth a damn; especially not Keynes. It seems everyone who wants to be taken verrry seriously plunges headfirst into the pro vs con Keynesian debate and then sits back as though they've actually enlightened someone.

Get over it! Wake up! No one with an IQ above room temp gives a damn about your pseudo-intellectual posturing! Sheesh!

Who supplied the income stream for these MBS and CDO for the past 2-3 years?

Foreclosures have been steady and growing for 2-3 years. This is nothing new. Without homeowners making monthly mortgage payments of interest and principal, the interest income for many MBS and higher order derivatives (CDO and CDO^2)should have stopped years ago.

Did it? If not, why?

Have Fannie and Freddie been supplying the income stream through their corrupt guarantees? Is that why they keep needing capital injections?

How did nobody hear about it? Not everyone could have swept it under the rug.

I agree that the QE money is and will continue to slosh back and forth between stagnant pools. Adding nothing to general economic activity.

Much has been made about how the Fed would vacuum those reserves back out of the system. But, I'm starting to wonder if the plutarchs do not perhaps have a different ending in mind. Could the Fed have been nominated to be a sacrificial goat, required to ingest the entire plutonium pâté platter? Then to die and be entombed with the toxic waste. Leaving behind banks now cleaned up and perhaps eligible to be merged with, oh say some Chinese banks. Is the end game nigh?

Great new posts I am going to have to read through again to ingest it all! (or more of it at least)

kjm - I second your "sheeesh"The Austrians vs the keynesians duel wears thin, especially when economics is more of an art than it is a science in any case. Both "schools of thought" are made up of diverse and errant people, humans, with their own prejudices, warts, and wrinkles!We are all in the middle of an evolving maelstrom far too complex for any one person to totally, or even largely, comprehend. BTW, while I like to read zerohedge, the comments prattle there about the Keynes/Austrians gets comical at times.Actually, here at TAE I find more of a variety of related subjects being discussed.

Stoneleigh suggests in her talks that in the US the best strategy for savings is to use TreasuryDirect and invest directly with the treasury. I'm thinking of doing that, but here's my question:

What's the best yielding investment given the expectation of deflation?

I ask this because it would be, for example, dumb to invest in TIPS since the yield is negative and we're unlikely to see inflation any time soon. Is there some sort of "deflation protected bond" or the equivalent? And what then is the difference between T-Bills, T-Notes, and T-Bonds?

I'll make this simple. I'll never vote for a Republican. Their policies are a betrayal to the people of America. The question now is- Why should I vote for a Democrat? Mr. Obama, your policies are just as damaging as the Republicans. You must start listening to people like Bill Black, who says that the TooBigToFail banks that have committed literally millions of frauds. Fire Geithner, Bernanke and Holder, all of whom perpetuate the problems our country is facing.

Bill Black lays it out very clearly the path you MUST take and the sooner you do it, the sooner we will see REAL recovery:"Closing the control frauds would actually benefit honest bankers by eliminating the "Gresham dynamics" created by fraudulent institutions -- a race to the bottom in underwriting. Since fraudulent banks use accounting fraud to manufacture high profits, they do not actually have to use a viable business model. By eliminating control fraud from the financial sector, it will be much easier for honest banks to succeed."

Black is right in his proposals, every single one of them. Bank of America, Citigroup and the others need to be taken over, and all the paper needs to see daylight. Every single day that doesn't happen costs Americans billions of dollars, it really is as simple as that.

Up here for the day to day I use a credit union because I get to know the people there and one can attend their meetings, but mostly because I really don't like the big banks. I do a small amount of online trading so am forced to use a larger bank for holding cash in that trading account.For true savings I had been putting that into gold as able to, but this past year into silver maple leaf coin, as I think it will do better and the smaller amounts are easier to buy on a regular monthly basis. ilargi may disagree about PM's but I feel that no matter what happens, in the end one will still have something tangible. Mad Max? ... well there are always wine goblets, nose rings and body piercing items to hammer out of that metal.

The longest duration I go with is 26 week (myself personally - the bulk of it "rotates" on 13 week duration ... with a smattering of 4 and 26 week).

Bills are anything with a duration not longer than a year (4 week, 13 week, 26 week, 52 week). You buy them at a discount (for example you might spend $99.92 for a $100 13 week bill... then in 13 weeks you get $100 back).

Notes are 2, 5, 7 and 10 year duration). Anything longer that 10 years is a bond. Notes and bonds you buy at par and receive interest payments over the course of owning the instrument.

The idea (basically) is that you don't want to be locked in for a long period of time.

I. M. the idea of recapitalizing the Fed is something that floats to the surface every now and then. It's an absurdity now w/ a $4t balance sheet, howzabout an $8t or $16t?

The Treasury would have to do it under an act of Congress and it won't happen. Fed is marooned in 'Extend- Pretend' land.

This is one reason (I think) the pressure remains to support the big money center banks is because the Fed is just as wobbly as they are. If the Fed's assets were marked to market the Fed would be insolvent. The only way it can dispose of its toxic assets is for its clients' balance sheets to expand and to do this these banks would have to make good loans - create good assets - to put against those they accept from the Fed.

Which the Fed cannot allow because to do so would cause short rates to rise, undoing the Fed and the Treasury at the same time.

RE: Obama's 'tax cuts' for 95% of Americans...I don't know anything about that. What I do know about is that well over 50% of the deductions Mr. TF and I have taken for the nearly 20 years we have worked in public health were no longer allowed and as a result, we once again owed over $1000. Now I read, thanks to I & S, that I am going to take yet another hit on the deductions -- mortgage interest and health insurance pretax dollars, and god knows what else. Looks like another banner year for the TF Ranch finances.

Great. Good to know now, so I can work even more overtime to pay for my upcoming taxes so that the richest 90% can continue to make money while doing nothing and pay basically zero taxes.

Ilargi - "Given the fact that right now the US election circus conveniently bogarts all media headlines, and that a likely Republican overall victory will paralyze the US political system afterwards, it looks more certain than ever that the answers will not be provided by the government whose constitutional obligation it is to find them."

It's a circus all right and the current mudslinging brings all the candidates even further down (they are already lower than Twain's Congressmen) in the eyes of the voters. If the system of paid politicos is limping along now, it will indeed screech to a halt after next Tuesday.Actually with the election and the QE the next day it could get interesting.

Forgive me if I assume too much here, but it seems like you are giving my admittedly insane sounding thought some support.

The Fed obviously is wobbly and looking to get a lot more wobbly. I'm afraid I don't understand how the Treasury could recap it even if the wholly owned Congress would approve it on a voice vote.

If the country is to be sold down the river, as appears to be the intent, what need would it have for a central bank anyway? Maybe the plan is to have it swallow most of the toxic paper and die. Taking the poison with it. That surely would leave quite a mess, but does it not seem that TPTB are not all that unhappy with Usanistan being a mess?

It strikes me as a daring play to upset the global applecart and force the world to subsist on their Lordhips' applesauce or go hungry. Maybe a large brain isn't such a survival advantage after all.

That looks like a fork, in the road ahead. One fork is said to lead you into the Bonfire of the Humanity as I believe Kunstler put it. The other is marked with a large sign featuring an image of a sun-bleached skull. Too bad we dropped that bridge over the gorge behind us. Just because some scoundrel shouted that there might be boogey men following us.

The old ways weren't nirvana by any means, but they weren't all that bad. At the pace of those days, the Long March to Extinction seemed likely to have remained a long one. At what looks to be the end of Progress Highway, there are reasons to wonder if the march will be greatly foreshortened.

@ Ilargi...I feel " cool " now and can't wait for an opportunity to use " bogart" as a verb.I miss that rascal, Dennis Hopper.I favor the rascals of this worldwhich is why I don't do well in " community ". They are often too structured and too righteous.

Yes Man I know the pain of hearing lpss as one becomes venerable ... or is that vegetable?

Anyway that was ... don't bone guard that joint my friend ... and not Bogart. Incidentally you remind me of a incident while herring fishing on the West Coast of Vancouver island in the 70's, the 'venerable' skipper in an attempt to seem a la mode, instead of saying, " come on lets go guys", said "lets boggie". He was told quickly that boggie was either an American actor or something one found in ones nose. At the time it seemed quite droll, but now that my hearing fades and I often find that I have dated myself, I find more sympathy for that old salt than I find ha ha at him.

@ Ilargi...I feel " cool " now and can't wait for an opportunity to use " bogart" as a verb. I miss that rascal, Dennis Hopper. I favor the rascals of this world which is why I don't do well in " community ". They are often too structured and too righteous.

The taxpayers would have to subsidize banks to 'buy' or swap toxic assets from to other banks.

There was nasty gossip in the finance blogospher when TARP was floated about a chunk being set aside to recap the Fed.

John Hussman takes the idea seriously. He took early exception to the Fed buying toxic GSE assets and other RMBS outright, essentially putting the taxpayers on the hook. If yr interested I can find the links.

The outcome in a law & order regime would be for the Fed to forfeit autonomy and become a money printer for Congress. Much of what the Fed has done since Bear has been unlawful. Nobody dares to touch them or the bigs because of fears of triggering another run.

CB's are needed for liquidity but the current model is not working. Punt!

Given that our law & order system only functions at the hoi polloi level, any presumption of what must, may or might be done by or to the Fed and big banks is subject to more uncertainty than Schroedinger had about his cat. But in case the Fed must die, maybe we'll be allowed to use the PBOC. It seems to have plenty of dollar reserves.

In “hot potato”, you pass the potato as quick as possible to avoid getting burned. But at some point an astute player may notice that it doesn't burn anymore. Most people think winning is "not getting burned", but a few know that winning is "amassing the cold potatoes".

Velocity refers to how many times each dollar is used in a year. That is velocity = GDP/money supply, but it’s really a distribution where some units cycle faster or slower. As Stoneleigh points out in the graph Ilargi posted today, money at rest does not play an active role in an economy.

When a central bank increases money supply, the effective money supply stays flat unless the new money starts to move. Where does the new money go? Money sold to banks is being hoarded (banks have record reserves at the Fed). Money sold to other institutions may be used to buy equities (and artificially pump the stock market). Money sold to the federal government is spent and actually moves. Precious little seems to reach average people, who are debt-addled, and finding it hard to maintain their spending.

So yes, the Fed can "just print money". But more QE implies that the Fed thinks the economy is very weak. Investors perceiving increasing risks or very low returns may increase their demand for cash. Businesses and individuals facing high debts and low return on investing in productive capital may choose to pay down debt or to build up cash reserves. So the harder the Fed prints, the more hoarding of old and new money will occur.

This is why the Fed wants people to believe that inflation is the risk. Fear of inflation increases velocity, since no one wants to hang onto cash as it loses value, thinking it's a hot potato that must be spent or invested. Fear of inflation could heat the cash at rest.

While the Fed has the power to increase money supply, large increases lead to decreased velocity and flat or decreasing effective money supply (and so no increase in GDP). Where oh where are those hot potatoes cooling down?

Fall guy - A very succinct and elegant post! Thank you.On this "...Money sold to other institutions may be used to buy equities (and artificially pump the stock market)." Amen, and I can guess that much of what is invested is placed in foreign companies and accounts which hardly benefit the U,S. taxpayer.

While no one can deny Tyler Durden's frantic and Herculean pace, with up-to-the-minute updates, and a wry Voltaire-ish writing style, your insightful commentaries remain a vital and valued addition to the reading digest on the "financial beltway".

Too bad people feel compelled to compare one voice to another, and while I don't agree with some of your views, here's hoping you and others never forget there's only ONE Ilargi.

The selling of Britain's forests still haunts me. Zander is on the job keeping any eye on the situation so I should let go. Nothing I can do about it and have my own Cdn forests to protect.I am going to say something that probably reveals how little I understand. Since I've already made " an ass " of myself why stop now,eh:)It is this ...I've read that most of the land/estates in Britain are in private hands, rich and royal hands that became rich either through inheritance or playing the corrupted finanacial system. These hands retain their wealth and land/forests because the public/gov't bailed out the banking system, maintained the status quo. So-o how come the private forests and estates aren't being sold off to replenish gov't coffers? Why is it those that didn't profit from the gaming, who are more indebted by the bailout,are now required to sell off their inheritance- the forests- to keep the game going?Why , in the gov'ts eyes, are private forests sacroscant whereas public forests are not. It appears that private ownership trumps public ownership. IMO this is unreasonable and unfair when the continued existence of the nation is at risk. Surely with the nation under atack from raiders and traders everybody should contribute to survival of the whole?Which brings me to the sell off of public assets in the US. Now that corporations are now " persons" they too must sell off assets to serve the nation. Again the sell off of public assets is a gross abuse of the commons.

Elliot Wave ..The reason the problem is only appearing now is that we are finally starting to see scheduled maturities in some of these instruments. Specifically the 5 year notes written in 2005 and the rather rare 3 year notes written in 2007. The bullet payment at maturity is the problem as many of these notes were written with the assumption that the bullet would be financed by restructuring the loans into new notes and selling them.. that clearly isn't happening. When the issuer can't refinance the note they will miss the scheduled maturity, in a plain vanilla bond issue this would be a default but in the case of RMBS and CMBS the scheduled maturity is NOT the legal final maturity. The legal final maturity is usually some period between 6 and 18 months after the longest loan making up the note is expected to mature. Some note holders are now looking at amortizing bonds with maturities between 2035 and 2042.

These note holders are obviously less than thrilled and they have a tremendous incentive (and a legal right) to force the issuers or originators of the underlying loans to:1) foreclose and dispose of any delinquent loans/properties 2) buy back any loans that did not measure up to the reps and warrantees written by the issuer

This problem isn’t new and isn’t a surprise, the data is and was all available, indeed it was a good part of the reason why the prices of these notes cratered and was to a certain extent priced in. What is new is the scope of the foreclosure problem, if the note holders are not legally allowed to foreclose and dispose of the properties in default then their best and indeed only option to recover their capital is to make a case and try force the issuers to buy back the non-conforming loans.

And it isn’t simply a matter of recovering their capital, this strategy also has a couple of significant benefits. The recovery is much faster than simply waiting for the loans to amortize out, the buy backs are typically at par which is not the case in a foreclosed property in this environment. Finally and quite possibly most importantly many of the note holders bought these notes at a significant discount to par, every loan they can force the issuer to repurchase at par represents additional return on investment.

Looking like Stewart caved in the Obama interview. I used to be a huge fan. Not so much now....Summers did a heck of a job! Ya right....When it is possible to bring Stewart to heel its game over. I'm suffering from abandonment issues:)My prince turned into a frog.

About those forests on the auction block...I promise my last comment on the subject.England sold off its gold at basement prices, $220 an ounce?Do ya think the bond market will be content to be paid in sawdust?Invest in ear plugs. The buzz of those chain saws is unbearable.

As Ilargi has said time and time again, this is a political crisis, not just a financial crisis. Because of this, the distortions we will see are likely to dwarf anything we can conjure from history, rendering the entire concept of "market" potentially obsolete.

apropos of nothing in particular, I just wanted to observe that I'm still having trouble with "QE2".

Rather than conveying to my inadequately caffeinated brain the vision of well lubricated money zipping through the digestive tract of the world, like grass through a goose; it keeps bringing to me the vision of a vast ocean liner.